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Monthly Sector Summary During September, large-cap banks fell 2.74% to a loss of 8.75% year to date, from August's loss of 6.20% and yields rose 13 basis point to 3.84% from August's 3.71%. The ten year treasury ended the month at 4.33% [vs 4.02% on 8-31 - a rise of 31 basis points]. During August, large-cap banks fell 1.62% to a year to date loss of 6.20% from July's loss of 4.65% and yields rose 17 basis point to 3.71% from July's 3.54%. The ten year treasury ended the month at 4.02% [vs 4.28% on 7-29 - a fall of 26 basis points]. During July, large-cap banks rose 1.48% to a loss of 4.65% from June's loss of 5.96% and yields fell 4 basis point to 3.54% from June's 3.58%. The ten year treasury ended the month at 4.28% [vs 3.91% on 6-30 - a rise of 37 basis points]. During June, large-cap banks fell to a loss of 5.96% from May's loss of 5.59% and yields rose 1 basis point to 3.58% from May's 3.57%. The ten year treasury ended the month at 3.92% [vs 4.00% on 5-31 - a fall of 8 basis points]. The point spread of the ten year's yield over that of the sector was 49 basis points at September's end, 31 at August's end, 74 at July's end, 34 at June's end, 43 at May's end, 61 at Aprils end, and 89 at March's end. Based on that short history, the spread rose every time it fell below 40 and fell every month it was above 40. The ten year's yield has been bound in a range between 3.9% and 4.5%. The rising fed funds rate along with future expectations that those increases will continue SHOULD have raised the floor on the ten years yield to slightly greater than 4.0%. So the ten year may be at its mid-point in the new fed adjusted range. And bank stocks are near [or slightly below] mid-point in their point spread - making this a neutral time to accumulate stocks in this sector based on these two powerful metrics. A Closer Look at Bank Stocks Stephen Simpson, CFA Motley Fool 8-31 Although there are well over 800 publicly traded U.S. banks, many investors shy away from this sector. The reported financial statements look funny, and the results don't neatly fit into the handy-dandy screens and formulae that many investors like to use. That's a shame, because as Warren Buffett has shown in the past, well-chosen bank stocks can be as lucrative as industrial, health-care, or technology stocks. While there are differences between money-center banks, regional banks, and savings and loans, that's a topic for another day. The Basics - Banks Pay Less for Deposits / Charge More for Loans Let's start off with a brief examination of what banks do. Simply put, banks are in the business of buying and selling money. Banks purchase money through deposits like checking and savings accounts, CDs, and debt or equity financing. Banks sell money by making loans or investing in securities. Banks buy low and sell high. Banks also make money from fees and service charges. And generate feed income by selling off almost all of their loans shortly after origination. Further, many banks also have other income-producing operations like asset management and insurance businesses. Interest rates are important to banks because they determine the price at which money is bought and sold. But it's not true that "rising/falling rates are bad;" good bank managers are neither stupid nor helpless, and they can adjust to different environments. To a large extent, the more important factor is how interest rates behave relative to a bank management's expectations. If managers are preparing for higher rates [by shortening loan duration in its portfolio and writing more floating rates loans, the use of interest rates swaps, while at the same time extending the terms on the banks sources of funds by getting the pricing right so that the bank sells more 2 year DCs and less 6 month CDs] and those higher rates don't materialize, it's likely that the business won't perform as well as hoped (and vice versa with falling rates). Unfortunately, there really isn't a handy ratio or formula to easily establish management's expectations. It requires paying attention to SEC filings like 10-Ks and 10-Qs and management comments during conference calls. Look for Growth in Depsotis, Loans, EPS There are many moving parts to a bank. It doesn't really have revenue in the normal sense of the word, but you can look at the combination of interest income (minus loss provisions) and non-interest income as a proxy. Clearly, you'd like to see these numbers going up. Deposit growth and loan growth are also both important. If deposit growth is weak, other more expensive sources of funds might have to be tapped. Likewise, if loan growth is sluggish, it will be more difficult for the bank to earn a profitable spread on the money it controls. Let's also not overlook earnings growth -- a growing bottom line is just as important to a bank as any other company. So, for all of the fancy or confusing concepts that follow, don't forget that income and per-share earnings growth are still important. Profitability is Found in Net Interest Margin and Efficiency Ratio As is the case with any business, profitability is paramount to banking success. Strong profitability can easily spell the difference between an average stock and an above-average winner. Net interest margin is a good baseline measurement of the profitability of a bank's core lending and borrowing business. Net interest margin is basically the difference between interest income (loans, securities, et al.) and interest expense (deposits, borrowed funds, et al.). In some ways, I suppose you could think of it as the gross margin of a bank. When analyzing net interest margin, I'd suggest you do so in the context of similar banks and their strategies. Among banks in similar lines of business, higher margins can be a sign of great management. But it could be the result of riskier lending policies. Narrower margins can suggest trouble on the deposit side and a higher cost of funds. Or it could mean more conservative lending practices. Context matters when comparing numbers. The efficiency ratio is another useful metric. There are different ways to calculate this number, but the fundamental underpinning is the same: It is designed to measure the ratio of non-interest expense to income. Ideally, you want this number to be as small as possible -- the smaller the number, the less being spent on things like marketing, salaries, and branch expenses, and the better the earnings. Captial Structure, Asset Quality, & Liquidity A bank's capital structure, asset quality, and liquidity are all important. Because the spreads on borrowing and lending money are relatively narrow, banks employ considerable leverage to pump up their earnings power. To make sure that banks don't overdo it and imperil their solvency, bank regulators impose limits. To be "well capitalized," a bank must have a ratio, expressed as a percentage, of risk-based total capital to total assets of 10% ("risk-based" refers to certain adjustments that are made to reflect that some assets -- like cash and treasury securities -- are less risky than others). Likewise, shareholders can examine the ratio of shareholders' equity to assets to get a grasp on whether the company is increasing or decreasing its leverage. Asset quality is important because if people don't repay their loans, the bank in question is going to have some problems. Some numbers to look out for include net charge-offs, the percentage of allowance of loan losses to total loans, and the percentage of non-performing loans to total loans. Watch their trends to see whether asset quality is going downhill. Liquidity is also important in the banking world, and it basically reflects how easily a bank can lend money. If a bank is very liquid and has a lot of cash on hand, it can respond very quickly to new opportunities. Of course, there is an opportunity cost associated with keeping cash on hand -- you may lose out on what you could make by lending it out. So if a bank is too liquid, it's leaving money on the table. There are two quick ways to check liquidity -- the percentage of assets held in cash and treasury securities and the loan/deposit ratio. Ideally, this latter number should be near 100% for most well-capitalized banks. Performance Measures: Return on Assets and Return on Equity All other things being equal, it's generally a good idea to invest with the folks who've proved that they can make the most money with a given amount of capital. One way to make that judgment is to look at a company's return on assets and return on equity. In a sense, these metrics capture the end result of a management's decisions on liquidity, leverage, credit quality, and other operational options. The one note of caution I'd sound on return on assets is that you should make sure you're comparing banks with similar business models. Banks that generate a lot of non-interest income, like Bank of New York, can sometimes require less assets on a dollar-for-dollar basis than more lending-focused banks. So comparing across these lines can give you misleading results. Return on equity is also highly useful for me. I like that you can break it down into net margin, asset turnover, and financial leverage and study how and why one bank may be better than another. Moreover, I've found that banks where management has consistently produced above-average return on equity are often above-average performers in the stock market. Know the Business There is no creature called a "typical bank" -- each has its own nuances and individual risk factors. Take beleaguered Doral Financial, for instance: While it looked good by the numbers and had a heck of a run, there was a ticking time bomb in how the company valued aspects of its mortgage operations. Had you simply relied on the numbers and not dug into the 10-K, you could have easily been fooled into thinking the bank was safer than it really was. Knowing the business is also important when you compare banks. Comparing a huge money-center bank like KeyCorp with a regional bank like Bank of the Ozarks just doesn't make sense. So the more you know about the business, the more likely you are to understand what the numbers are really telling you. Don't Overthink This We have offered this brief treatment on bank stock analysis to help you with your evaluations of these stocks. But as is always the case, numbers tell only a certain side of the story. It's important to do your own due diligence and strive to really understand the policies, strategies, and expectations of the company in question before buying a small piece of it. True, the banking sector has some unusual ratios and metrics for measuring performance, but don't get bogged down in the details. Ultimately, the pattern of success behind a bank stock investment is little different than that for most any other company -- a pattern of consistent growth in earnings, dividends, and assets, skillful and honest leadership, and expectations of further growth. Wachovia Agrees to Buy Westcorp Valerie Bauerlein, WSJ 9-13 Wachovia agreed to acquire Westcorp for about $3.91 billion in a deal aimed at boosting the company's heft in the auto-finance business while giving Wachovia its first branches in California. In addition to making Wachovia the ninth-largest auto lender in the U.S., the takeover quiets speculation at least for the moment that the bank is about to make an even larger acquisition of a commercial bank or consumer-finance company. The purchase price represents only about 5% of Wachovia's stock-market value, which analysts said seemed reasonable given Westcorp's size and reputation for being well-run. "This gets Ken [Thompson] his foothold" in California, Nancy Bush, a bank analyst with NAB Research said, referring to the Wachovia chief executive. Westcorp's 19 bank branches in Southern California could help Wachovia decide whether to open additional branches in the state or make another acquisition. Most of Wachovia's roughly 3,100 branches are in the Southeast, though it has been opening new branches in growing markets such as Texas and New York. Westcorp originates, securitizes and services loans through 8,300 auto dealers. It also is strong in the subprime market, which is lucrative because customers pay higher interest rates but risky because those customers default more often. Wachovia's previous auto-lending business was focused on borrowers with the most pristine credit records who typically buy pricey cars. Wachovia has used that business to build relationships with dealers, who sometimes need wealth-management services or loans to build inventory. The combined company's auto-finance portfolio will consist of 78% prime loans and 22% subprime loans, according to Kevin Fitzsimmons, an analyst with Sandler O'Neill & Partners. Fifth Third Shares Hit 5-year Low Cincinnati Business Courier 9-16 Fifth Third Bancorp shares on Thursday fell 5.1%, to their lowest close in five and a half years. The bank reported trouble managing interest-rate changes and adding deposits, leading to several analyst downgrades. "The earnings bleed continues," wrote Fox-Pitt Kelton Inc. analyst Jon Balkind, who rates the bank "underperform." In a regulatory filing Wednesday, FITB said it had trouble with the "flattening yield curve," caused by the failure of long-term interest rates to follow short-term rates higher since the middle of 2004. Fifth Third said its net interest margin will have a "double-digit basis point contraction" from the second quarter's 3.29%, and that net interest income will go down. A.G. Edwards and Citigroup Research downgraded Cincinnati-based Fifth Third to "hold" from "buy," Credit Suisse First Boston cut it to "neutral" from "outperform," and Prudential cut it to "underweight" from "neutral weight." "The new news raises issues not only about future earnings but also about the degree that management, much of which is newly reconfigured, has control over the numbers," wrote Prudential analyst Michael Mayo. Card Companies Are Filling Up At the Station Margaret Webb Pressler, Washington Post 9-25 As the price of gasoline rides the storm tides of two hurricanes, one group is crying all the way to the bank. Major credit card companies are reaping huge profits from rising gas prices because the fee that banks charge gas stations to process a credit card transaction is based on a percentage of the purchase price. As gas prices go up, the processing fee goes up. Since last year, the fees that gas stations paid to credit card companies have risen 64%, right along with the price of gasoline. "It's unexpected revenue, because people are just doing what they were always doing," said David Robertson, publisher of the Nilson Report, a credit card industry newsletter. "It's not like a whole new market opened up. There's no behavioral change. It's just more money." And lots of it. On a typical day, Americans buy 382 million gallons of gasoline, according to the Energy Department's Energy Information Administration. About 70% of that is paid for by credit card, said several trade associations representing gas stations. The credit card processing fees paid by gas stations, meanwhile, average about 2.5%, these trade groups agree. A year ago, when gas prices averaged $1.87, banks involved in credit card processing made about $12.5 million a day on fees. Now, with prices averaging $2.75 nationally, the companies are raking in $18.4 million a day. That is $183 million more a month, or nearly $2.2 billion dollars on an annual basis in extra money paid to the nation's banking giants just because of rising gasoline prices. Adding to the difficulty for gasoline retailers is the fact that consumers are using credit cards more often for those costlier gasoline purchases. The National Association of Convenience stores says that since Hurricane Katrina, the percentage of gasoline purchases on plastic has gone up 10 points, to 80%. Each oil company's own branded credit card charges its station owners lower fees, but those cards account for a small -- and decreasing -- percentage of sales at retail gas stations. Debit cards also have slightly lower fees than traditional credit cards but only represent about 16% of total card transactions. It is major credit cards offering frequent-flier miles and rebates that get swiped the most, by far, these groups say. But there is growing pressure on the industry to rein in its fees. The lead plaintiff in a class-action lawsuit against the credit card companies for merchant fees has seen a wave of interest in his case because of the gas-purchase profits. "As gas prices have doubled, so, too, have the earnings for the banks that own the credit card associations," Mitch Goldstone said. "What I proposed to the CEOs of both Visa and MasterCard is to very simply suspend the interchange fees at all service stations." Wall Street analysts say that for each individual financial institution, the growing profit from gasoline purchases is not huge compared with the total profit for the companies. Three of the biggest credit card issuers, Citigroup, MBNA and Capital One, all declined to comment on the increased profits they are getting from gasoline transactions. But banking industry experts say the trend is in keeping with the increasing profits that banks are making in general on consumer fees of all kinds. In the meantime, said F. Peter Horrigan, president of the Mid-Atlantic Petroleum Distributors' Association, some service stations are fighting back. An increasing number are bringing back discounted prices for cash purchases or even rejecting credit card purchases altogether. "It is the number one issue in our industry right now," Horrigan said. September Ratings Changes On 9-07 Piper Jaffray Upgraded JPM from Market Perform to Outperform. On 9-16 A.G. Edwards and Citigroup Research downgraded FITB to "hold" from "buy," Credit Suisse First Boston cut it to "neutral" from "outperform," and Prudential cut it to "underweight" from "neutral weight." Deutsche Bank upgraded the two Swiss banking giants, UBS and Credit Suisse Group [CSR: $46.22 P/E 13.06 and yielding 2.80% as of 9-09], to buy from hold. For both banks, Deutsche upped estimates on higher assets under management in the private banking operations and the prospect of a sustained increase in M&A activity. Deutsche also is of the view that the rest of the European banking sector is seeing an erosion of free cash flow generation, but that the cash flow generative nature of private banks will allow UBS and Credit Suisse to continue with buybacks. (Steve Goldstein, MarketWatch 9-07) August Ratings Changes On 8-25 Sandler O'Neill Upgraded STI from Hold to Buy, reversing the 7-20 Downgrade from Buy to Hold. On 8-11 Goldman Sachs Upgraded NFB from Underperform to In-Line. From David Weidner, MarketWatch 8-15: Merrill upgraded PNC to buy from neutral, citing increased confidence in its earnings estimates for 2006, strong earnings momentum in the second half of 2005 and 2006 and PNC being well positioned to benefit from the current interest-rate backdrop. In addition, the broker told clients it believes the market isn't fully grasping the EPS growth implications of PNC's recently unveiled "One PNC" efficiency improvement initiative. Monthly Mid-Cap Bank Sector Summary During September, mid-cap banks fell 3.67% to a year-to-date loss of 6.23% and yields ended at 3.58% [vs August's 3.44% - a rise of 14 basis points]. The ten year treasury ended the month at 4.33% [vs 4.02% on 8-31 - a rise of 31 basis points]. During August, mid-cap banks fell 2.74% to a year-to-date loss of 2.71% from June's year to date rise of 0.13% and yields ended at 3.44% [vs July's 3.32% - a rise of 12 basis points]. The ten year treasury ended the month at 4.02% [vs 4.28% on 7-29 - a rise of 26 basis points]. During July, mid-cap banks rose 4.13% to a year-to-date gain of 0.13% from June's loss of 3.78% and yields ended at 3.32% [vs June's 3.46% - a fall of 14 basis points]. The ten year treasury ended at 4.28% [vs 3.91% on 6-30 - a rise of 37 basis points]. During June, mid-cap banks rose to a year-to-date loss of 3.78% from May's loss of 5.98% and yields ended at 3.46% [vs May's 3.56% - a rise of 10 basis points]. The ten year treasury ended the month at 3.92% [vs 4.00% on 5-31 - a fall of 8 basis points]. Investors Bet Economic Recovery In Hurricane-Stricken Region Will Aid Financial Institutions Robin Sidel, Valerie Bauerlein and James R. Hagerty WSJ 9-08 The bright red sign atop Hancock Holding Co.'s headquarters is illuminated again -- and that could be a good sign for investors. The 106-year-old bank, based in Gulfport, Miss., is one of dozens of regional and national financial institutions with large operations in the areas devastated by Hurricane Katrina last week. The FDIC estimates that some 280 locally based institutions may have been affected by Katrina, representing $270 billion in assets and $201.3 billion in deposits. Big names in the area include Regions Financial, AmSouth, Compass and Whitney Holding Corp. Although the stocks of some affected banks tumbled last week when the storm's devastation became apparent, investors are betting that the area's economic recovery will generate enormous revenue and loan growth next year. "As an investor, you can take some reassurance in the fact that after an initial period of loss of business, there will be a lot of cash and insurance proceeds flowing into the area," said James Schmidt, a portfolio manager at John Hancock Funds. Like the banks, analysts are scrambling to determine the extent of the damage and how it will affect earnings. In addition to getting stuck with bad loans, banks are likely to incur costs to repair their own facilities and reinstate services to customers. The storm came at a delicate time in the banking industry. In recent months, bank profits have been squeezed by a flattening yield curve. The profit pinch has prompted some institutions to cut costs and free up funds that have been set aside for bad loans. Now, they may have to add more to those loan-loss reserves, which could take a bite out of earnings. "It is unclear the magnitude of an impact that the recovery will have on bank earnings, but we believe that it is likely that results could be impacted for at least a few quarters," Kenneth Usdin, analyst at Bank of America, wrote in a report Tuesday. The report didn't quantify a potential impact. Richard Bove, an analyst at Punk Ziegel, estimated that Regions could face a billion-dollar loan loss from the storm, resulting in a $1.35 hit to per-share earnings. Still, "we would ignore this write-down if it occurs" due to "a steady stream of new businesses that will flow into this bank as southern Louisiana and Mississippi are rebuilt," he wrote in a report released yesterday. "There will be credit issues," said Chris Spoth, acting director of supervision and consumer protection at the FDIC. "However, the banks were in very strong condition going into this crisis." Banks can turn to the Federal Reserve and the Federal Home Loan Banks for emergency short-term loans if they experience a shortage of cash, though Mr. Spoth said "we haven't seen" much of an increase in demand for such loans. Still, the wrath inflicted by Katrina is far different than that of Hurricane Hugo, which ravaged Charleston, S.C., in 1989 or Andrew, which swept through Florida in 1992. Although those storms inflicted billions of dollars in damages that took years to repair, there were far fewer questions about the ability of those communities to rebuild. In New Orleans, the bulk of the city remains underwater, and it isn't clear if displaced residents -- now scattered around the country -- will ever return. "The eventual reconstruction of the marketplace is going to be bigger [than other storms], but there will be more pain felt by the banks in the wake of this hurricane versus others," said Jefferson Harralson, an analyst at Keefe, Bruyette & Woods. Unlike some of its more diversified rivals, Hancock has a 43% market share in its namesake Hancock County, one of the areas hardest hit by Katrina. The bank has $4.7 billion in assets and 107 branches. A branch in Bay St. Louis, Miss., was one of three destroyed by the storm. Another branch located just east of Gulfport was obliterated. "What's left is the vault and the sign," said Richard Hill, executive vice president, based in Baton Rouge, La. But after listening to a conference call with Hancock executives late Tuesday, Andrew Stapp of boutique research firm Cohen Bros. raised his rating on the bank to "buy" from "hold." "We believe the market is overreacting with regard to the impact of Hurricane Katrina on [Hancock] and perhaps is underestimating the long-term benefits associated with recovery efforts over the next several years," Mr. Stapp wrote in a research report. Still, he lowered earnings estimates for the bank for 2005 and 2006 based on an increase in loan-loss provisions. The bank, for its part, thinks its exposure to bad loans "is relatively limited," said Michael Achary, the bank's treasurer, who is based in Gulfport but is working out of the Baton Rouge office. In any case, Katrina is expected to cause a surge in defaults on home mortgages. In Louisiana alone, officials have estimated that as many 160,000 homes were ruined. Insurers will bear the costs of replacing those houses in many instances. To the extent that destroyed homes aren't insured against flooding, lenders or other holders of mortgage debt will face possible losses. But "most investors have very low exposure to the affected areas," said Peter DiMartino, a strategist at RBS Greenwich Capital, an investment-banking firm. That is because mortgage risks are widely dispersed among lenders and investors around the world. Most U.S. home loans are bundled into mortgage-backed securities and held by banks, insurance companies, pension funds and other investors -- and most have a small exposure to the region hit by the storm. Most lenders will allow borrowers in affected areas a grace period to delay repayments without facing extra fees, the Mortgage Bankers Association said. Fannie Mae and Freddie Mac, mortgage-funding providers established by Congress but owned by investors, own or guarantee around half of the $8.3 trillion of U.S. residential mortgage debt outstanding. Spokesmen for both companies said they are still assessing the situation and can't estimate its financial effect. Based on the experience of past hurricanes, neither company is likely to face major losses. The credit risk on most mortgages that aren't backed by Fannie, Freddie or the Federal Housing Administration is borne by holders of so-called nonagency mortgage securities. Mortgage analysts at UBS AG in New York released a report this week estimating that less than 1% of the amounts due on loans backing such securities are in the ZIP Codes most affected by Katrina. August Ratings Changes On 8-26 Sun Trust Rbsn Humphrey Initiated coverage of SUSQ at Neutral. On 8-26 Sun Trust Rbsn Humphrey Initiated coverage of FULT at Buy. On 8-22 AG Edwards Upgraded TCB from Hold to Buy. On 8-18 JP Morgan Initiated coverage of SUSQ at Underweight. On 8-17 Prudential Initiated coverage of WL at Neutral. On 8-16 Advest Initiated coverage of FULT at Buy. From Lisa Sanders, MarketWatch 8-25: Shares in AmSouth fell 24 cents to $26.09 Thursday after Punk Ziegel downgraded the stock to market perform from buy. The SEC issued a Wells notice, which is non-public, to AmSouth, informing the bank that the agency may bring action against it for alleged violations of federal securities laws. The potential violations relate to the company's mutual fund business. "This puts the bank in a position where outsiders simply have no idea what is happening internally," said Dick Bove, an analyst at Punk Ziegel, in a note to clients. "The risk has become greater than the reward in this situation." NOTE: Please confirm through your own research any numbers on which you are to make a buy, sell or hold decision. The page is ment to be a supliment for those already getting monthly sector updates from their broker. It is the goal of this page to provide more timely data - and perhaps cover a wider array of stocks and different valuation metrics. Data entry errors sporadically happen. Home Page Factoids Previous Update |