Go Ahead, Pick a Bank While It’s Down

The smart money is buying banks when practically all other investors are treating them like toxic waste.

Laurence Tisch and his family have bought stakes in three banks in economically troubled New England--9.9% of Bank of Boston, 9.5% of Bay Banks and 5% of Shawmut National, a holding company for banks in Massachusetts and Connecticut. Tisch, the 67-year old chief executive of CBS, has also invested in Chase Manhattan, Chicago’s Continental Bank and Pittsburgh’s Equimark through a family investment company managed by one of his four sons.

An investment group led by Warren E. Buffett, the 60-year-old billionaire from Omaha, has bought 9.8% of Wells Fargo.

Smaller investors like banks, too. Some executives of Bank of America and Security Pacific recently put their money where their jobs are and bought more stock in their companies.

Such enthusiasm seems bewildering amid mounting concern about bank failures. Bank stocks are selling at what look like low prices, but most analysts believe that they will fall lower, as loans on commercial real estate go bad.

Loan losses on real estate have already cut bank profits in many areas, particularly New England, and the pressure is on to cut dividends. European banks are even becoming wary of extending credit to U.S. banks, reports a U.S. government official.

Bank regulators are worried. L. William Seidman, chairman of the Federal Deposit Insurance Corp., concedes that real estate is in trouble: “There’s enough vacant office space to accommodate all the current office workers of New York, Chicago, Los Angeles and San Francisco combined.”

But that means that banks will restructure, not fail in great numbers, Seidman says. “We’ll see a basic restructuring of U.S. banking in 1991, brought about by mergers and new laws in Washington.” Seidman is talking about repealing laws that limit interstate banking and prevent banks from getting into other businesses--profound changes in the business.

And that’s just when smart investors get interested. They know real estate is falling and there’s a recession around the corner. But they also know that during times of change a business can produce extraordinary gains.

Right now, the smart investors are looking past the credit crunch to lower interest rates and past the recession to long-term promise in banking.

They don’t expect to lose their money. Rather than bank failures, they foresee a speed up in mergers, which boost profits because they cut overhead expenses. When banks merge, after all, they can get rid of one computer system--and numerous executives--yet serve more customers. The example always cited is Wells Fargo, which doubled profits after merging with Crocker National in 1986.

Until recently, mergers were rare among the nation’s 10,000 banks because bank presidents, just like other people, don’t like losing their jobs. However, the present crisis is likely to force the issue, and the 10,000 banks may shrink to 6,000.

Fine, but what good is merging to cut expenses if plummeting real estate threatens the banks’ very solvency? Banks get hit when property values fall because real estate developers and other borrowers default or miss interest payments. And banks can suffer accounting losses, too, if regulators demand that loans be marked down on the books, even though borrowers keep paying interest and principal. Both problems are hitting New England, where commercial values have fallen 20% in recent years and may fall further.

But smart investors assume that the severity of the situation will bring government action. The Federal Reserve is certain to lower interest rates now, a leading economist says.

And regulators will take a longer view, Seidman suggests. “As they should,” says Chairman Victor Riley of KeyCorp., a holding company with banks in eight states. “Our company lived through the energy downturn in Alaska, when real estate was in free fall,” Riley says. “So we told the regulators, give us three years, the market will calm and we’ll establish a value.”

Riley is talking sense. Snap evaluations of properties in unstable markets lead to uneconomic prices; think of having to sell your house tomorrow regardless of price. With a longer perspective, more reasonable values are established.

The Tisches recognize that. They’re investing in New England because they know that the region’s true business potential is better than the recession makes it appear.

In California, Buffett’s group may take a short-term beating if Wells Fargo is hurt by declining real estate, says analyst Raphael Soifer of Brown Bros. Harriman. “But longer term, he has bought a good business franchise--the leader in financial services in Northern California, with a chance to acquire First Interstate’s position in Southern California.”

And that’s an important point. Smart investors such as Tisch and Buffett don’t worry about buying at the absolute bottom price and making the last nickel. They’re looking for the big long-term dollars as the business changes and grows.

They bought into CBS and ABC in 1986 when the outlook for networks was poor. And it has become even poorer. But Tisch and Buffett are not selling, even though they have a profit in their holdings. They remain focused on the changing economics of global entertainment, not the ratings of a single season.

Now they see similar potential in the banks. They could be wrong, of course. But they didn’t get rich being wrong.