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Is your state a tax haven or hell?
"Mister Bank" could be the financial sector play you've been looking for
After a long lull, bank stocks are ready for the plucking
by Charles R. Wolpoff
Wealth protection is a means of taking control of your financial destiny, of making your money work for you, not the other way around.
And right now, one good way to put your money to work is by owning a bank.
I'm not suggesting that you embrace the bank mentality. Rather, we're suggesting that this is the time for you to take your revenge on banks. They've been taking your money long enough. Start taking some of theirs.
In some ways, banks share characteristics with the bad guys we try to warn you about. Banks use every means in the book to separate you from your money: setting outrageous ATM fees, making you pay for checks, imposing ridiculous charges for overdrawn accounts. Let's face it. When was the last time you heard someone say they loved their bank?
It certainly doesn't help matters that the big banks keep getting bigger by gobbling up any bank they can sink their teeth into. It's senseless for banks to post their names on your checks anymore. By the time you get halfway through one batch of checks, the bank's liable to be owned by another bank three times its size, and three
hundred times further away.
Here in Baltimore, we can still remember the days of Equitable Bank. That was gobbled up by Maryland National. Which was acquired by NationsBank. Which was, in turn, swallowed by Bank of America. You've probably seen the same cannibalistic scenario played out in your neck of the woods.
And the bigger banks get, the less they care about customer service. In today's world of 24-hour this and 24-hour that, banks have refused to change their hours to help their customers. Sure, they give you a few evening hours on a Thursday. But for the most part it's bankers' hours, just like in the old days.
Oh, in many ways times are changing. For example, Internet banks are becoming bigger players. But for now, banking is still mostly bricks-and-mortar.
As a result, all we get are the very large banks, and the very small ones that are too small for the giant national and regional banks to notice. That's what bank insiders mean by the "barbell" effect. Lots of huge banks on the one side, lots of small community banks on the other, and few medium size banks in between. So, speaking of barbells...
Time for a wealth workout
This is all rather sad, perhaps even tragic, and certainly annoying. We would all prefer to think our money was being handled by neighborly folks who actually cared about our town and the people in it. But let's not waste time shedding tears. Let's make money instead.
In fact, with all their faults, that's one thing banks do well: they make money. Tons of it.
And they have enough financial and political clout to make sure the rules continue to favor them enough so that they can continue to make tons of money.
Why do you think Congress has passed legislation in recent years tearing down the barriers (the so-called "Glass-Steagall" rules) that used to separate banking from stock brokerages and insurance? Now banks can be all-purpose financial service providers. Because that's where the money is. And that's what they wanted to do.
No matter what happens, they end up on top. Even when a bank occasionally gets into trouble, government is forced to bail the institution out.
Banks have been around as long as Western civilization. And if there's a nuclear war, the only ones left standing will be cockroaches, the IRS — and the banks.
Banks: Despicable, greedy, disgusting
So what can you do about it? Take revenge.
And, as the saying goes, the best revenge is...living well. And you can do that by buying bank stock. Banks don't go out of business. At the right time in the investment cycle, the right bank stock will make you lots of money. And the stronger banks will pay you consistently growing dividends even when bank stocks overall are in a down cycle.
All the way to the bank
Banks have been in a down cycle until recently. The banking sector has gone through some rough times. But that just means there is more opportunity to pick up some real buys.
1999 was the worst year for bank stocks since 1994. That trend continued into the early part of this year. In January alone, bank stocks dropped more than 5%. Through May, they fell a collective 4.6%. At one point this year they were off about 20%. And for the last year the bank index has underperformed the S&P 500 by about 25%.
What caused all the problems? First, the banking industry is tremendously cutthroat. It's big fish eats little fish, acquire or be acquired. This has tended to put downward pressure on bank stocks.
Next, there's Alan Greenspan, the chairman of the Federal Reserve and president of the "We Hate Bull Markets" Club. Like the Puritans of old, he is frightened to death that people might make too much money in the stock market, that too many people may be employed, that somewhere, someone is truly, outrageously happy.
He's called it "irrational exuberance," which means that some investors may be making as much money as he is. So he does what he can to restore some fiscal sanity, to make sure the stock market doesn't keep going up, that houses don't stay affordable, that the economy doesn't keep rolling along.
And his weapon is the prime interest rate. He has raised this rate five times since last July. This seems to have had the desired effect. Investors are scared. The market's had a tough time keeping its footing. And the economy's slowed down. If you lose your job soon, you may have Mr. Greenspan to thank.
Banks are hurt in several ways by rising interest rates. You see, one of the traditional ways banks make their gobs of money is by lending your cash at higher rates than the rates they pay you for depositing your money there. For example, while you're making a measly 2.3% interest on your savings account, the bank is issuing a home mortgage to some sucker for 8.3%.
Hefty spreads
But as interest rates rise, those old 30-year mortgages the banks issued way back when are still earning the lower interest rates. Meanwhile, they have to increase the interest rate they pay you. And as the rates rise, the demand for loans starts to shrink.
In addition, as the interest rates slow the economy, the demand for loans also slows.
Not all banks are hurt equally by rising interest rates, although investors — like the sheep that they tend to be — often act as if they affect all banks equally. This gives you a chance to buy stock in certain banks at bargain prices. More on that later.
Another problem that sent bank stocks into their recent swoon was the cooling off of merger mania. Back in 1998, a flurry of big bank mergers was hyped as being wonderful for investors. But those mergers were slow to pay off. The monster banks that did much of the acquiring had a difficult time consolidating their latest conquests. Too much of their resources were devoted to getting all the pieces in place. And in late 1999, mergers that were expected to happen — that investors were counting on — failed to materialize. Too many of the target banks were seeking excessively high prices.
Remember Y2K?
The world was going to collapse, civilization was going to unravel, and there would be an epidemic of bank runs that would make the panic of 1929 seem like Mardi Gras. Not too many investors were interested in banks. Now the tide seems to have turned for bank stocks and, indeed, the entire financial sector. The Y2K scare is ancient history. In fact, the Cassandras who made it their business to predict (and profit from) dire consequences are now pitching dot-com IPOs.
As the November elections loom closer, not too many observers expect the Fed chairman to raise rates again, for fear of appearing too partisan. The talk on the street is that banks are set to enjoy a summer rally. Besides, bank stocks tend to rally in the summer anyway, after overcoming routinely mediocre first quarter results.
As if to signal the coming rally, one day in May an index of 225 banks jumped 3.9%. Major banks like Bank of New York and Mellon Financial are near their 52-week highs.
You may think banks aren't the type of investment that can give you a huge gain in a hurry. But look at State Street Corp. From a low of less than US$60 in September it has climbed to more than US$120 in mid-May.
It's not too late to join the party
If you want to buy a bank now, which one should you choose? We suggest that you not use your bank stocks for the part of your portfolio where you anticipate three-figure gains in a few months.
Rather, you should use financial stocks, and bank stocks in particular, for safe, though very solid returns — while also ferreting out the banks most likely to be targeted for acquisition. In other words, the right bank can give you the best of both worlds. Safe returns and, at the right moment, huge capital appreciation as well.
It may be tempting to go after the biggest institutions, such as Bank of America, Wells Fargo and Citigroup. But if you do so, be aware that these banks are vulnerable to economic downturns, due to their equity underwriting and venture capital business. These giant banks may share some of the same volatility as tech stocks.
Besides, the bigger banks aren't going to be acquired. They're the acquirers. As such, they're the ones that have to deal with the inefficiencies of huge acquisitions.
Take Chase Manhattan (CMB). It, like other large banks, is digesting too many acquisitions. Plus, it is too exposed to the New Economy. One estimate is that 63% of its portfolio is in such stocks. Also, a quarter of its earnings in 1999 was in venture capital. And this leaves it more vulnerable to a downturn in the market.
To be sure, it's getting tougher to find these potential targets. But they're still out there.
Don't get me wrong! The potential for acquisition is not the only factor you should be looking at. You want a bank that stands on its own. That's going to make money whether it's picked up or not.
What about those rising interest rates?
While banks as an industry may start moving up because, as we said, many expect Greenspan to raise interest rates no more than one more time this year, you do want a bank that is relatively insulated from the damaging impact of interest rates. Look for a bank that makes variable rate as opposed to fixed rate loans.
And you want a bank that stands out from the crowd.
Mercantile Bankshares Corp. (MRBK:NASDAQ) of Baltimore fits the bill. This bank has earned an impeccable reputation locally. Through all the changes in the banking industry — mergers, expansion into other financial services, cutthroat competition — this bank has stood firm. It's been a rock largely because of the integrity and independence — some would say stubbornness — of its long-time chairman, H. Furlong Baldwin.
This is a large community bank (US$8 billion assets) with personality. For example, the stodgy, aging, bankerly Baldwin is affectionately known as "Baldy" by the industry press and his peers. The bank itself is jokingly called Mister Bank, because of its ticker symbol, MRBK. But that moniker also seems to fit perfectly.
Mercantile has set itself apart from the rest of the banking industry. "Baldy" is the one to whom other bankers come when they fear they're going to be acquired by an impersonal, out-of-town giant.
Mister Bank, perhaps, should be called Sir Bank — it is considered the white knight of the region. It buys up small community banks and lets them continue to run their businesses as they were. "Baldy" realizes that these banks know their communities better than he does. So he doesn't demand total subservience from his acquisitions. The merged companies get to run things pretty much their way.
This conservative and very well-managed bank has increased its earnings every year for 20 years. And it has steadily increased its dividend over that same period.
Most of the banks that made good acquisition targets — large, regional banks — have already been bought up. Why hasn't Mercantile?
For one reason, and one reason only. "Baldy." He has steadfastly refused to sell.
But his contract is up in February 2001. And most industry insiders expect him to retire at that point.
Good news or bad?
Clearly, it's bad news in the sense that the bank would lose the captain who has so magnificently steered his ship all these years. But, having developed a decentralized system with a proven track record that doesn't depend on just one man, "Baldy" has prepared his company well for the days when he is no longer there.
The bank should continue to run fine without "Baldy" — until it gets bought up.
And that's where the good news comes in. When "Baldy" moves out of the way, it's highly unlikely that anyone else will have the willpower withstand the blandishments of the inevitable suitors. Baldwin has stood firm against selling to another bank. His pending departure opens the way to a possible acquisition. And that, in turn, could pave the way to big gains for investors like you.
What is the effect of a potential buyout? Just look at the experience of another bank named Mercantile — Mercantile Bancorp in St. Louis. Simply on a rumor, one day in 1999 the stock went up more than 11%. Investors who bought the stock the week before the merger announcement would have gained about 30%.
In any event, merger rumors will likely escalate as "Baldy" nears retirement. And that should give the stock a healthy boost. Wait until those rumors become reality and you're likely to miss the boat.
Don't get us wrong. Any acquisition of Mercantile by an out-of-state-bank — some industry analysts expect Wachovia to be the one — would be unequivocally bad news for Baltimore, the state of Maryland, and the bank's customers and employees.
But, lest we forget, banks are generally the bad guys anyway, right? And we're in this for revenge — to make money off the leeches who are making money off of us.
So shed some tears for the potential victims, if you like. But don't let your tears dim your vision while you're counting your gains. And while you're waiting for the merger, good things may still happen. Mercantile is well insulated from interest rate hikes. Their fixed-rate loans are relatively short term. Their longer loans are generally variable rate. Thus, when Greenspan ups the rates, Mercantile gets to increase what it charges on its longer loans.
Right now the stock is selling between US$33 and US$34. One concern is that it has seen a pretty hefty rise in the last couple of weeks. You may want to wait until it dips to around US$30.
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