Banking stocks look less `ugly'. Debt moves, Japan, new Fed chief help out

The ``big and uglies'' are blossoming into beauties. OK, maybe that's a tad effusive for money-center banks still saddled with hefty Latin American loans. But the metamorphosis is arguably under way.

Last week, Security Pacific and Bank of Boston joined Chase Manhattan and Norwest in beefing up their loan loss reserves. Citicorp ignited the trend two weeks ago by setting aside $3 billion.

The Citicorp and Chase reserves now cover about 25 percent of questionable foreign debt. Other banks have pumped reserves up to the 35 percent level.

``I like those `big and uglies' - particularly Citicorp and First Chicago,'' says Nancy Young, a financial analyst at Tucker, Anthony & R.L. Day. ``They're `ugly' because the perception is that these lumbering banks don't know what they're doing. That's false. They're clearly putting the [debt] crisis behind them.''

Adding to reserves does hurt bank earnings in the near term. But it means balance sheets more accurately reflect the banks' true conditions and that they are willing to admit these loans are mushy now rather than pile on more questionable loans and slide into a debt crisis later. The move also gives banks more flexibility in future negotiations with debtor nations.

Bolstered by these developments, Thomas Brown, an analyst with Smith Barney, Harris Upham, last week put out a strong buy recommendation on Citicorp, J.P. Morgan, and Bankers Trust.

``Given that secular progress on LDC [less developed country] debt has begun,'' he says, ``and Smith Barney's belief that interest-rate fears have peaked near term, upward revaluations of both the regional and money-center banks appear due.''

Investors were making ``upward revaluations'' in the 30 Dow industrials last week but trading was light ahead of the economic summit in Venice this week. The Dow Jones average closed at 2,326.15 on Friday, up 34.58 points for the week.

Two other events might also benefit banks in the long run: Alan Greenspan's designation as next chairman of the Federal Reserve and Japan's opening of its securities industry to United States banks.

Since 1979, Fed chairman Paul Volcker has been cautious about knocking down the Glass-Steagall wall limiting bank participation in the securities business. Mr. Greenspan, a deregulation advocate, voices no such qualms.

And in Tokyo, banking barriers are coming down faster - partly due to blunt congressional criticism that Japan enjoys advantageous access to US markets. The Ministry of Finance told four US banks (J.P. Morgan, Manufacturers Hanover, Bankers Trust, and Chemical Bank) they could get approval for a securities unit.

Neither development will have much immediate impact on stock prices. ``This represents an opportunity in the future, rather than a major new earnings stream now,'' points out J.Frederick Meinke, a banking analyst at E.F. Hutton.

Still, couple these developments with the bargain-basement prices, and bank stocks could prove enticing. Rising interest rates have discouraged investors in recent months. As a result, the big and uglies are cheap. Money-center banks are trading between five and seven times 1988 earnings, or at slightly less than book value.

``Revenues are climbing,'' says Ms. Young at Tucker Anthony. ``Losses are flattening out. I think we may be at the end of the loan loss cycle.

``The worst news on interest rates is behind us,'' she adds. ``If the economy is getting healthier, bank customers are getting stronger. The facts are all in place. But the market hasn't recognized it yet.''

That is the rub, agrees William Raftery, a Smith Barney technical analyst. While banking analysts favor the group, market technicians don't. ``We're still negative on the banks,'' says Mr. Raftery. ``Their prices have stabilized a bit here, but that doesn't suggest they're ready to go up in a major way. These stocks may be `undervalued,' but investors aren't buying them yet. The market may be wrong, but technicians stay with the trend.''

Smith Barney technicians believe the trend for the next few years will be in cyclical stocks.

Chris Kotowski, a bank analyst with Oppenheimer & Co., also eschews the big and uglies. He recognizes progress on LDC loans but thinks it remains an unresolved problem. In short, these ``actions are not sufficient to make us fundamentally bullish on the group,'' he writes in a recent report.

Mr. Meinke at Hutton likes Morgan, Security Pacific, and US Bancorp but would hold off on bank stocks as a whole.

``It's probably premature to be buying,'' he says. ``The group is poised for a move, but it won't happen until the end of the summer or in the fall.''

The catalyst for investors will probably be a breakthrough in the Brazil debt negotiations. Talks start this month but could go on for several months. Also, says Meinke, interest rates need to decline or stabilize.