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Stock Analyst Update

Bank on More Consolidation in Banking

Managers, analysts speculate about who will go to the altar next.

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There will be more mergers and acquisitions among regional banks, but the consolidation probably won't match the feeding frenzy seen in other quarters of the financial sector.

The week is not even half over and it's already been a busy one for bank mergers, with Firstar (FSR) buying US Bancorp (USB) for more than $21 billion and FleetBoston Financial (FBF) acquiring Summit Bancorp (SUB) for $7 billion.

The deals come on the heels of a flurry of banking mergers in recent weeks, including the combinations of Chase Manhattan (CMB) and J.P. Morgan (JPM), and Citigroup (C) and Associates First Capital (AFS). They also presage more banking mergers, particularly among regional companies seeking ways to grow their mature businesses. "It's been a big week for deals in the banking industry," said Lisa Welch, a bank analyst with John Hancock Funds. "To the extent that we do still have buyers and sellers, or at least buyers, I think it is going to continue."

 Financial Funds with the Biggest Stakes in Bank Stocks
% of
Total Assets
in Bank Stocks
YTD
Return
( % )
3-Year
Return
( % )
Rydex Banking (RYKAX) 88.23 9.74 N/A
Fidelity Select Banking (FSRBX) 88.06 10.61 6.24
John Hancock Regional Bank (FRBFX) 79.18 6.26 0.07
SIFE Trust A-1 (SIFEX) 78.31 10.65 4.61
FBR Financial Services (FBRFX) 63.98 26.54 6.34
Penn Capital Select Fin Services (M)$-BFAJ 53.62 15.53 N/A
Emerald Banking & Finance (HSSAX) 52.87 5.67 -4.20
Pilgrim Bank & Thrift (PBTAX) 49.53 13.96 1.44
Banc Stock Grade (BANCX) 47.98 -1.08 -0.46
Kemper-Dreman Fin Services (KDFAX) 45.93 17.51 N/A

But don't expect the same type of merger frenzy that has sent brokerages and securities firms--including UBS (UBS) and PaineWebber (PWJ); Goldman Sachs (GS) and Spear, Leeds & Kellogg; and Credit Suisse Group (CSGKY) and Donaldson, Lufkin & Jenrette (DLJ)--scrambling to the altar. Banks likely will be more selective, observers say. "I don’t think its going to work like the brokers," said Adam Levy, an analyst for the Invesco Financial Services fund (FSFSX). "I think we are going to continue to see deals, but I don’t think there's going to be a mad rush to do them."

The conditions seem right for more bank consolidation. There are more than 8,000 banks in America and, therefore, a lot of opportunities for combinations and cost savings. "We still believe that that number is going to get a lot smaller," Welch said.

Competition and interest rates have trimmed some banks' spread income, or the difference in what they pay in interest on deposits and what they make off of loans and fees, and made it hard to grow earnings, analysts say. Earlier in the year, uncertainty about the course of the Federal Reserves' interest-rate policy also hurt some regional-bank stocks, making them relatively cheap. So some bank managers may see opportunities to grow through acquisitions, analysts said.

 U.S. Diversified Funds with the Biggest Stakes in Banks
% of
Total Assets
in Bank Stocks
YTD
Return
( % )
3-Year
Return
( % )
Hennessy Cornerstone Value (HFCVX) 24.85 0.10 4.32
Alleghany/Chicago SmCap Val (ASCVX) 20.91 12.90 N/A
Stratton Growth (STRGX) 20.83 18.88 8.53
Quaker Large-Cap Value (QUESX) 20.63 -12.31 4.01
Fifth Third Equity Income (FSSIX) 20.22 6.52 9.30
Neuberger Berman Focus (NBSSX) 19.69 23.43 18.30
Evergreen Sel Strategic Value (ESSIX) 19.47 -2.22 N/A
Cutler Value (CALEX) 17.77 1.42 9.20
Mercantile Equity Income (AEPIX) 17.49 4.99 5.68
Granum Value (GRVFX) 17.21 7.53 5.98

It's hard to predict who might be next, but a list compiled from interviews includes AmSouth Bancorporation (ASO), Hibernia (HIB), KeyCorp (KEY), First Union (FTU), Associated Banc-Corp (ASBC), and Union Planters (UPC). Some of these banks have had difficulty growing earnings, Welch said.

Impending accounting rule changes also could encourage consolidation. The Financial Accounting Standards Board may ban pooling-of-interests accounting, which lets merging companies combine their balance sheets as if they always have done business together. Instead, firms would have to use the purchase method of accounting, which forces businesses to include goodwill, or their merger partners' intangible assets, on their balance sheets and write it off over time. Typically, companies that use the purchase method report lower earnings as a result of the merger than those that pool their statements. The change lends some urgency to banks that have been considering mergers, but are worried about hurting their reported earnings. "If they were going to get them done, they have to do it now," said Morningstar.com stock analyst Laura Pavlenko Lutton.

But while there may be some regional bank managers interested in selling, there may not be enough buyers to fuel rapid consolidation, analysts say. The market is stinging from problem-plagued deals by Bank One (ONE), First Union, Bank of America (BAC), and KeyCorp, Welch said.

Morningstar.com stock analyst Harry Milling said regional banks' low stock prices also restrain them. "I think a lot of the regional banks are stymied by the fact that they are cheap stocks so they don't have the currency [to do deals]," Milling said.

Mergers and buyouts will happen, but they will have to make strategic sense, Milling said.

And observers said the merger of Firstar and US Bancorp makes sense. It gives Firstar access to a new geographic area--the West--and to more fee-based revenue from US Bancorp's investment banking and wealth management businesses. Firstar has an exemplary track record of applying its efficient and customer-focused retail banking business model to other banks it has acquired, but there is concern in some quarters about corporate indigestion. "I think the combined franchise is attractive, but it's a big deal and it is going to take a while to integrate," said Invesco's Levy. "It's going to be a show-me deal."

Dan Culloton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.