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Annual reports, shareholder meetings in the spring air

Banking Today

With spring approaching, so is the season for bank annual reports and shareholder meetings. Routinely, many investors toss the slick publications and invitations with nary a glance. But with bank-company shares taking a pummeling — as of press time, they’re down 30% from last year’s highs — shareholders are taking a closer look.

While many experts agree that bank stocks are being hurt by concerns over rising interest rates and slowing merger activity, others concede that the stocks are being hit by the tech-heavy Nasdaq’s success.

Says Jim Schmidt, lead manager of John Hancock Regional Bank Fund in a recent Wall Street Journal interview: “Nasdaq’s sucking all the oxygen out of the air of the room the financial stocks breathe in.”

Indeed, Schmidt acknowledged that the fund has faced “a couple million” dollars a day in redemptions for a year now.

Since 1999 was hardly a picnic for bank stocks in general, and 2000 rolled in like a bad hangover for some big-bank stocks, what should investors glean from annual and quarterly reports? Moreover, what should investors be asking of bank management after their analysis of pertinent data?

Bank stock analysts say there are several critical issues to consider. Obviously, key performance ratios are a starting point. But numbers alone don’t always tell the full story and investors would be wise to probe beyond surface-level statistics.

This is particularly true in the area of earnings. During the past year, some analysts have been attentive to and critical of what they call “lower-quality” earnings. For the most part, this means a reliance on too many “one-time” items. Analysts say investors should look at abnormally low loan-loss provisions, market-sensitive revenues, as well as gains from the sales of specific businesses or branches. According to Credit Suisse First Boston analyst Michael Mayo, items like the above should be evaluated in terms of their impact in the broader scale of earnings.

Another area of strategic analysis involves revenue growth and efficiency. For years, banks have understood that investments must be made in technology and delivery mechanisms to expand competitive marketing opportunities in the longer term. Bankers have also recognized that they must make investments to achieve “the next level” of efficiency gains. But analyst Mayo says CSFB’s research shows that many banks are spending more money simply to maintain existing market share — hence the name of a recent CSFB report called “Running Harder Just to Stay in Place.”

“For some banks, the ability to get to the next level of competitiveness will require significant pain, and in some cases, banks won’t be able to do it,” Mayo asserts.

During the past decade, some analysts like Mayo state that banks took the easy way out by “grabbing the low-hanging fruit” when it came to efficiency strategies. In other words, some banks took the obvious path of cost cutting by whacking headcount and branches to make short-term numbers look good. But they didn’t develop a longer-term efficiency strategy. Indeed, analysts like Mayo state that the next level of efficiency gains will involve generating revenues at lower marginal cost — a much tougher proposition than slashing expenses. In reality, this has proven to be much more challenging for banks in recent years.

Says Mayo,”It’s trickier to gain new customers on the Internet than it is to close 100 branches or to fire 2,000 people.”

Another critical area of interest involves management depth and experience. Analysts say they’re looking more closely at marketing, sales and technology proficiencies for senior executives employed throughout the company. Nowadays, technology isn’t just the chief information officer’s domain. Professional disciplines are more integrated by necessity throughout various lines of business. Executives who are charged with leading the bank should be versatile in these experiences. In some instances, this versatility is gained from previous leadership positions outside of the commercial banking and/or financial services industry.

Analysts say investors should take a keen interest in consolidation strategies. Is management focused on expansion for ego’s sake? Is there a solid business rationale for expanding into new geographic areas? Or is the rationale vague? Moreover, how do acquisitions ultimately fit into broader revenue and efficiency goals?

Says Morgan Keegan analyst Christopher Kelley,”Acquisitions should be explained from the perspective of where the bank is going strategically and why the acquisition makes sense in terms of stated goals.”

While no one knows where bank-stock prices will go from here, shareholders should take the time to read through banks’ financial reporting materials and ask relevant questions as appropriate.

Simultaneously, bankers should consider the results of a recent Pricewater Coopers study. It found that two-thirds of bank chief executives believed their bank’s stock was undervalued.

Obviously, that’s no surprise. But only 10% of bank investors and 21% of bank analysts found the company financial reports very useful, the study concluded. If communication is the key to understanding, then the study suggests there may be a lot of work to be done.

Tupelo-based journalist Karen Kahler Holliday writes a monthly banking column for the Mississippi Business Journal. She is senior contributing editor for U.S. Banker magazine.


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