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Factoids Large-Cap Banks Mid-Cap Banks Banking News Bankstocks.com Prior Banking Updates Nov 2005 Oct 2005 Sept 2005 August 2005 July 2005 June 2005 May 2005 April 2005 March 2005 Feb 2005 Jan 2005 Dec 2004 Nov 2004 Oct 2004 Sept 2004 August 2004 July 2004 June 2004 May 2004 Feb 2004 Jan 2004 Dec 2003 Nov 2003 Oct 2003 |
Monthly Sector Summary During November, large-cap banks rose 3.94% to a loss of 1.66% year to date, from October's loss of 3.76% and yields fell 14 basis point to 3.57% from October's 3.71%. The ten year treasury ended the month at 4.49% [vs 4.57% on 10-31 - a fall of 8 basis points]. The point spread of the ten year's yield over that of the sector was 78 basis points at November's end. During October, large-cap banks rose 3.76% to a loss of 5.40% year to date, from August's loss of 8.75% and yields fell 13 basis point to 3.71% from September's 3.84%. The ten year treasury ended the month at 4.57% [vs 4.33% on 9-30 - a rise of 22 basis points]. the spread was 86 basis points. 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]. 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 - up until October. Can PNC Stick to Turnaround Plan? Clint Riley, WSJ 12-08 Three years ago, PNC Financial Services Group engendered disdain on Wall Street. Regulators swarmed around Pennsylvania's largest bank after the company improperly accounted for $762 million in bad assets. There were calls for the resignation of Chairman and Chief Executive James Rohr. Investors shunned the company. PNC's stock was trading at less than $40 a share, down significantly from highs of more than $70 in early 2001. These days, PNC at $64 is close to a 52-week high, giving the company a market value of almost $19 billion. Some analysts believe the nation's 14th-largest bank based on market capitalization will continue to deliver for shareholders in 2006, despite anticipated industrywide head winds from rising interest rates and increased credit losses that are all but certain. And there has been speculation that PNC could be a takeover target. Since October, when PNC reported a 29% increase in Q3 profit, several firms -- including Merrill Lynch and Morgan Stanley -- have raised 2006 earnings estimates and price targets for the company. "They had been doing everything wrong for a long time," said Richard Bove, an analyst at research firm Punk Ziegel who is bullish on PNC with a "buy" rating and a $70 price target. "Now, the bank has its three divisions all working in the right direction." The consensus earnings estimate for PNC next year is currently $4.87 a share, compared with an estimate of $4.78 a share a little more than a month ago, according to Thompson Financial. "Life is pretty good for next year," PNC's Mr. Rohr said in a recent interview. "I'm comfortable with $70 a share with what I know." So far this year, PNC's stock performance is far outpacing other large U.S.-based regional banks. PNC's stock price is up almost 10%, while the widely watched Keefe, Bruyette & Woods Bank Index, which measures two dozen large U.S. financial-services firms, including PNC, is down 0.06% for the year. The bank currently trades at a rich 13 times analysts' consensus 2006 estimate. PNC shareholders have enjoyed even better results since Oct. 13 when the long-struggling banking sector began enjoying a "relief rally" following better-than-expected Q3 earnings and increased expectations that a cooling economy will prompt the Federal Reserve to stop raising short-term interest rates sooner rather than later. Asset management is one reason PNC's stock has outperformed both large and regional banking peers. This year, BlackRock Inc., a publicly traded asset-management firm 70% owned by PNC, has delivered stellar earnings for the bank. BlackRock, with $428 billion under management, earned $189 million in the first nine months of this year, up 45% from the prior year. Its stock is up about 40%. Another reason for the bank's financial success is PFPC, the company's mutual-fund processing business, which has produced double-digit net income growth this year. Combined, BlackRock and PFPC have accounted for about 20% of PNC's total revenue this year. Unlike with many other banks, those fee-producing revenue streams have helped the bank, with $88 billion in assets, better insulate itself against revenue declines caused by the tightening yield curve, increased credit risk and a slowing home-lending market. Despite those positives, not everyone is prepared to hop on the PNC bandwagon just yet, arguing that the stock is pricey and that the bank has a spotty history of executing its strategic plans. Some investors and analysts still aren't convinced that PNC and its management have changed their ways for good. PNC's business culture until recently was widely described in the investment community as overly bureaucratic and less than cost conscious. "There has certainly been a lot of turnover in the management ranks below the CEO. But the CEO remains the same," said David Hilder, an analyst at Bear Stearns who maintains an "underperform," or "sell," rating on the stock. Neither he nor his firm hold any of the shares. Mike Holton, manager of the T. Rowe Price Financial Services Fund, whose firm owns 1.4 million PNC shares in several mutual funds, credited PNC for conducting a "dramatic turnaround," but he acknowledged that he still isn't a "big bull" on the stock. Right now, he said, PNC is simply less risky than many other bank stocks. Mr. Rohr has promised Wall Street that PNC, which is expected to earn about $1.3 billion this year, will realize at least $300 million in cost savings, about half of which will come through the elimination of 3,000 jobs from its work force of 23,700. The company said it is expected to produce at least $100 million in new revenue by fiscal 2007. PNC earned $5.5 billion of revenue last year. Some analysts and investors say if retail- and commercial-banking revenues fall in 2006 any increased revenue produced by the effort will provide the bank an edge over rivals with fewer options to prop up earnings. Mr. Rohr said he understands his company must produce strong growth, not just promises, in 2006 to win more converts. He is certain his company will deliver. "There are people who believe, there are people who say we're a safe bet and there are those who say 'Show us,' " Mr. Rohr said. "We are going to have to show them." Does the Financial Stock Run-Up Have Legs? Buckingham, Gongloff, Patterson, WSJ 12-02 Financial stocks are on a tear, which has surprised some market watchers who say bank bets are bad bets when interest rates are rising. This week, John Buckingham, portfolio manager and president of Al Frank Asset Management, who specializes in value-based investing strategies, shares his thoughts on why financial stocks are good investment over the long haul [along with WSJ writers Gongloff and Patterson]. Mark Gongloff: Like other financial stocks, regional banks have rallied lately -- the Keefe, Bruyette & Woods Regional Banking Index has risen nearly 12% since mid-October -- which seems to make no sense whatsoever, given the ever-shrinking spread between long- and short-term interest rates. In principle, smaller regional banks that do more plain-vanilla banking -- holding your money for you, making small loans, giving away toasters, etc. -- suffer far more than bigger, diversified banks when the "yield curve" flattens, since they're paying higher short-term rates on deposits without a matching rise in longer-term interest income on loans. In real life, it's more complicated than that, and FTN Midwest Research analyst Jeff Davis says some regional banks deal with a flattening curve better than others. Georgia bank Synovus, for example, said it managed to boost its net interest margin -- the difference between interest income and interest expense -- in Q3, even as the gap between short- and long-term yields was cut nearly in half. Most analysts have "hold" ratings on Synovus and other regional banks, noting the flattening yield curve and the likelihood that banks will suffer as credit quality is dragged down by rising interest rates. In fact, of all sell-side analysts' ratings for the 16 regional banks in the S&P500 index, just 23% are "buy" ratings, according to research by Citigroup chief equity strategist Tobias Levkovich. That is the sixth-lowest among 118 sub-industries in the S&P 500, according to research from Citigroup, which crunched Bloomberg data. But 62% of all their ratings are "holds," the ninth-highest of the S&P500 sub-industries. Many analysts are simply tepid on the group, believing it too expensive after a long run of salad days. Banks' forward price-to-earnings ratios typically run at a discount to the S&P 500's forward P/E ratio, but that discount is historically low right now, according to Sandler O'Neill analyst Kevin Fitzsimmons, at 24%, compared with an historical range of 20% to 50%. But the industry is ripe for consolidation, and merger activity could goose the stock prices of some smaller regional banks, the most likely buyout targets. But small banks have recently rallied, too -- in part because of merger hopes -- and their P/E multiples are typically higher than those of the bigger regional banks, making them tougher to swallow. Scott Patterson: Since bank stocks hit a low point in early October, the Nasdaq 100 index of financial companies has shot up 12%, compared with a 7.4% gain by the S&P500 index. Thank derivatives. One reason investors, chiefly institutional traders, are comfortable buying bank stocks right now is the growing popularity of complex products like interest-rate swaps, says Jeff Kleintop, chief investment strategist at PNC Advisors. Rate swaps can help banks use rising short-term interest rates to pad their top lines when at the same time those rising rates flatten the yield curve and take away the easy money of the "carry" trade. (The spread between the yields on two and 10-year Treasurys was at 0.09 percentage point late Thursday.) Here's one way derivatives work: A company, say Coca-Cola, exchanges floating-rate income with a bank for income that has a fixed rate of return. Coca-Cola gets a cleaner balance sheet and steadier cash flow even if rates suddenly fall; the bank gets fatter interest payments the higher short-term rates go. The risk for the bank: a sudden drop in short-term rates. Rate swaps can help banks stabilize earnings, Mr. Kleintop says. The risk for investors is that they are mostly in the dark since banks rarely detail their positions. In its 2004 annual filing with the Securities Exchange Commission, for instance, J.P. Morgan Chase said it "utilizes derivative instruments, primarily interest rate and cross-currency interest rate swaps" to protect against swings in currency-exchange and interest rates. Even if banks did detail their results, most investors wouldn't be able to understand the nuts and bolts anyway, said Kent Engelke, capital markets strategist at Anderson & Strudwick. "There are only a few people in the world who can understand all the hedging and derivatives positions" at the large commercial banks, he says. Derivatives use complex formulas based on assumptions about how the market will operate under certain conditions. Suffice to say, these bets don't always pan out. Hedge funds lost billions of dollars in May on seemingly sure-fire bets on GMs stock and bonds. A more infamous example is the Long Term Capital Management meltdown seven years ago. Derivatives have uses, but overconfident banks may be taking on too much risk. John Buckingham: Most investors are well aware there is little difference between short- and long-term interest rates. Conventional wisdom argues that a flat yield curve is detrimental to the earnings of banks. But investors with an investment horizon longer than a few weeks shouldn't let these concerns dissuade them from holding financial stocks. The lion's share of selling because of the yield-curve has already happened. And it isn't even certain that a flattening yield curve will wreak havoc on financial-sector profits. History shows most banks, savings and loans and brokerage firms have been able to smoothly navigate through all sorts of interest-rate environments. Be it their ability to hedge interest-rate risk with derivatives, reap significant recurring income from fees, or diversify into complimentary businesses, earnings for financials haven't been that interest-rate sensitive for a decade or so. That doesn't mean financial stocks are immune to shifting rates, but it does mean that because so many investors are convinced otherwise -- and, more importantly, have adjusted portfolios accordingly -- opportunity knocks for investors looking for bargains in the sector. Two examples: Bank of America, the No. 2 bank in terms of capitalization behind Citigroup, trades at 11 times its earnings from the past 12 months, and has a dividend yield of more than 4%. (Al Frank funds invest in Bank of America.) More industry consolidation is likely to be a positive catalyst going forward, and investors could soon warm to the relatively consistent growth exhibited by most players in the sector, the below-market P/E ratios and the generous dividend yields. Most folks have shown little interest in midsized and large-cap names that dominate the financial space -- small caps, with great growth potential, have been all the rage -- but in the long run, value almost always gets recognized. US Card Issuers Eye New Bankrupts James Kelleher, Reuters 12-02 A record number of Americans filed to wipe out their debts this year ahead of the autumn implementation of a tough new bankruptcy law. That surge in filings forced U.S. credit-card issuers like Citigroup and Capital One Financial to report a huge jump in uncollectable debts in the third quarter and to warn the losses would bleed into the fourth quarter. The bankruptcy bubble has forced the card issuers to set aside big amounts to cover the unprecedented surge in charge-offs. It's also forcing them to scramble to rebuild their diminished loan portfolios, which are already under stress because of new federal guidelines on minimum payments requirements that are cutting into receivables and interest income, according to analysts at Citigroup Global Markets. As they consider their options, some in the industry are reportedly mulling a strategy that concerns consumer advocates -- signing up the consumers who just had their debts discharged. Sound crazy? It's not. For starters, the new bankruptcy law requires debtors to come up with a payment plan to satisfy unsecured creditors like the card companies. So the newly bankrupt are actually pretty good credit risks. But that's not all. In a world where the average creditworthy American already has more than four general-purpose credit cards and where response rates to direct-mail solicitations touting zero-interest teaser rates have fallen below 1%, experts say the newly bankrupt have much to recommend them. Among their attractions: a tendency to engage in behaviors that generate hefty finance and penalty fees and bring fat profits to the issuers. "The credit-card companies can't afford to lose these people," said Robert D. Manning, a professor at the Rochester Institute of Technology and author of the book "Credit Card Nation." "They've really come to count on them." According to Lundquist Consulting, nearly 2 million Americans filed for bankruptcy from Jan. 1 until the Oct. 17 implementation of the new law, up nearly 52% from the same time last year. In the old days, burned card issuers would have treated the people like untouchables and either denied them credit for up to seven years -- or steered them into secured cards. No more. "Lenders are going to go after them again and offer them money," Capital One Vice President Mike Rowen told listeners at a recent conference hosted by CIBC World Markets. During the conference, Rowen checked off for his listeners the things that make the newly bankrupt so attractive to some lenders. For starters, they are debt-free, which means they're in a much better position than the average U.S. consumer to pay off any new bills in the face of rising interest rates, higher fuel prices and a slowdown in the real-estate market. What's more, Rowen said, because the new U.S. bankruptcy law that went into effect in mid-October forbids anyone who declares bankruptcy from doing so again for anywhere between two to eight years, the newly bankrupt are customers who will -- by law -- have to pay a substantial portion of their new debts. "The people that get discharged are going to get access to credit right away," Rowen said, "because once they're discharged, you know, they can't file for bankruptcy for a long time again." The newly bankrupt are also card-free and keen to re-establish credit, making them much easier marks for direct-mail solicitations than their overcarded, nonbankrupt peers. And because they're so grateful to get their mitts on plastic again, the newly bankrupt will swallow the punishingly high interest rates that the credit-card companies will charge them because of their so-called "subprime" status. "It's diabolical," said Travis Plunkett, legislative director of the Consumer Federation of America, a nonprofit watchdog group in Washington. "They'll hit them with terms that will give the word 'onerous' a new meaning." A final reason the card companies will welcome back the recently bankrupt with open arms? The companies really miss them. Their bankruptcies aside, these customers were pretty profitable, said Ed Groshans, a specialty finance analyst at Fox-Pitt, Kelton. "Those were the ones who were getting late fees, over-limit fees, and probably bounced a check every once in awhile," allowing the card issuers to hit them with one lucrative charge after another, Groshans said. "Those were like nuggets of gold on a company's top line." USB to Sell $2 Billion of Convertible Senior Debentures to do Buy-Back Business Wire 12-05 U.S. Bancorp announced that it had priced a private placement of $2 billion aggregate principal amount of its floating rate convertible senior debentures due 2035 (the "convertible debentures"). The convertible debentures will bear interest at a floating rate equal to three-month LIBOR minus 1.46%, payable quarterly in arrears. The convertible debentures have an initial conversion rate of 27.1370, representing an initial conversion price of $36.85, which is a premium of 20.0% over U.S. Bancorp's closing stock price of $30.71 on December 5, 2005. U.S. Bancorp will use a portion of the net proceeds from this offering to fund repurchases of up to 4.1 million shares of its common stock simultaneously with this offering and expects to use the remainder for general corporate purposes, including possible additional share repurchases. If converted, holders of the convertible debentures will receive cash up to the principal amount of a debenture and, if the market price of U.S. Bancorp common stock exceeds the conversion price in effect on the conversion date, holders will also receive a number of shares of U.S. Bancorp common stock per convertible debenture as determined pursuant to a specified formula, subject to U.S. Bancorp's option to cash settle all or some of its delivery obligations. Wells Fargo: A Top-Quality Dividend Payer Lisa Dixon, Kiplinger 12-01 James Glassman, a columnist for Kiplinger's Personal Finance, suggests investors pay special attention to dividend-paying stocks. Among other things, he says, they're a good way to collect some income while you wait for a sideways market to come to its senses. One dividend payer to consider is Wells Fargo, says Glassman. The stock yields 3.3%, and the company has a history of healthy dividend increases: It's raised the dividend at an average annual rate of 16.5% over the past ten years, he notes. Value Line analyst Randy Shrikishun says future growth in the payout looks likely. Shrikishun doesn't expect the stock, which is trading only slightly higher for the year, to be a breakout performer over the next several months. But he says the shares do offer the potential for above-average capital appreciation over the next three to five years. He gives the stock top marks for "safety" and sees it as a good choice for conservative, long-term investors. Morningstar analyst Craig Woker also likes Wells Fargo. He says the company is one of the best in the banking industry, and it has "a sound strategy for generating solid returns." Wells, the fifth largest bank holding company in the U.S., focuses on selling multiple financial products to its customers. Already one of the top mortgage providers, the company is also focused on growing its share of the mortgage-origination market, Woker notes. Woker says that the biggest risk to the stock is its growing home-equity loan portfolio, including home equity lines of credit. Although he says these assets appear to be doing fine now, he says the company has yet to live though a correction in a regional housing market. "If one occurs, and if these assets default in numbers exceeding Wells Fargo's forecasts, the firm could stumble quickly." At $63, the stock sells for 13 times the consensus 2006 earnings estimate of $5.02 per share. BB&T to buy Main Street in $623 mln stock swap Reuters 12-15 BB&T, the No. 9 U.S. bank, said on Thursday it plans to buy Atlanta's Main Street Banks in a $622.7 million stock swap to strengthen its presence in the U.S. Southeast. BB&T said the deal is its first bank acquisition in over 18 month. North Carolina-based BB&T said the transaction, which is expected to close in Q2-06, would boost it to fifth from sixth position in deposit market share in both metropolitan Atlanta and Georgia. BB&T said this was its first bank acquisition since it acquired St. Petersburg, Florida-based Republic Bancshares in April 2004. BB&T bought 17 banks and thrifts from 2000 to 2004 before announcing a moratorium on bank acquisitions to refocus on organic revenue growth and cost control. Citigroup Sees Branch Expansion Overseas Reuters 12-16 Citigroup chief executive Charles Prince said on Friday the company plans to expand its international consumer businesses as it seeks to increase revenues outside of the United States. The bank has no plans to sell any more of its major businesses, nor does Prince expect it to make any major acquisitions, preferring small add-on deals in the future. Prince said the company plans to open 150 to 200 retail bank branches outside the U.S in 2006. He also sees expanding the bank's international consumer finance division by up to 500 branches and about 150 automated loan machine locations in 2006. "International GDP is expected to grow substantially more than U.S. GDP over the next few years," he added. At the same time, Prince expects revenue growth, excluding acquisitions, in the mid-to-high single digit percentage range, but net income would exceed that. Prince said the international retail bank branch network will expand in Russia, Chile, Turkey and other countries, while the consumer finance network will increase its presence in Mexico, Brazil, Poland, Spain, South Korea, Thailand and other countries. In the United States, similar to its overseas plans, the bank will focus on building growth in 2006 rather than on acquisitions. Prince said the bank plans to open 70 to 100 retail branches in the United States next year and between 125 and 200 consumer finance branches. Consumer finance comprises personal loans, mortgages and auto loans, often marketed to people with poor credit. When speaking about the bank's use of capital going forward, Prince says the bank will continue its current share buyback program and even expects to finish it early. December Ratings Changes On 12-16 Sun Trust Rbsn Humphrey Upgraded RF from Reduce to Neutral. On 12-15 UBS Upgraded KEY from Neutral to Buy. On 12-15 Morgan Keegan Initiated WB at Outperform. On 12-14 UBS Initiated BK at Neutral. November Ratings Changes On 11-29 Hillard Lyons Downgraded BBT from Buy to Neutral. On 11-28 Ryan, Beck & Co Downgraded BBT from Market Perform to Underperform. On 11-23 Sandler O'Neill Downgraded BBT from Hold to Sell. On 11-23 Sandler O'Neill Downgraded STI from Buy to Hold. On 11-18 Morgan Stanley Downgraded JPM from Overweight to Equal-weight. On 11-17 Sun Trust Rbsn Humphrey Initiated NFB at Buy. On 11-14 FTN Midwest Downgraded NFB from Buy to Neutral. On 11-16 Sandler O'Neill Downgraded NCC from Buy to Hold. On 11-03 UBS Initiated FITB at Neutral. On 11-03 Friedman Billings Upgraded PNC from Market Perform to Outperform. Monthly Mid-Cap Bank Sector Summary During November mid-cap banks rose 2.64% to a year-to-date loss of 2.74% and yields ended at 3.48% [vs October's 3.53% - a fall of 5 basis points]. The ten year treasury ended the month at 4.49% [vs 4.57% on 10-31 - a fall of 8 basis points]. During October mid-cap banks rose 1.39% to a year-to-date loss of 4.99% and yields ended at 3.53% [vs September's 3.58% - a fall of 5 basis points]. The ten year treasury ended the month at 4.57% [vs 4.33% on 9-30 - a rise of 24 basis points]. BancorpSouth Expands Alabama and Arkansas Franchises PRNewswire 12-05 BancorpSouth announced that it is expanding its presence in Alabama and Arkansas with recent openings of loan production offices in Gulf Shores, Alabama located on the Alabama Gulf Coast in Baldwin County, and in Fayetteville, Arkansas located in Washington County in Northwest Arkansas. The loan production offices will specialize in commercial real estate lending, real estate construction and residential mortgage lending. FNB Announces Balance Sheet Restructuring And Efficiency Initiatives PRNewswire 12-07 F.N.B. Corporation announced a repositioning of its balance sheet designed to further reduce exposure to an anticipated rise in rates and improve future net interest income levels. In addition, the Corporation has taken action to improve the efficiency of its customer service and will record non-recurring expenses related to severance and benefit costs. As a result of these actions, the Corporation expects to incur approximately $11.2 million in after-tax charges, or $.19 per diluted share, in the fourth quarter of 2005. First, the Corporation plans to dispose of approximately $570 million of available-for-sale, fixed-rate investment securities with an average yield of 4.13% and an average life of three years. Concurrently, $100 million of federal funds purchased, which reprice daily, will be retired at a current cost of 4.15%. The remaining $470 million will be reinvested in securities yielding approximately 4.90% and an average life of two years. In addition to providing cash flow for the funding of future loan originations from the Corporation's expanding Pittsburgh markets and the new Florida loan production offices, this action will reduce interest rate risk and improve the net interest margin. By executing this repositioning, the Corporation expects to recognize an after-tax charge of approximately $9.5 million. At this time, the Corporation estimates that it will recover these costs through earnings over the ensuing three years. The balance sheet restructuring will likely have a minimal impact to the corporation's stockholder equity as the decline in value of the investments is currently reflected in "accumulated other comprehensive income." Second, in Q4-04 F.N.B. received an acquirer's stock in exchange for its minority interest in Sun Bancorp Inc. (Sun). Since the consummation of that transaction, the acquirer's stock has declined in market value. Based on the lapse of time and consistent trend of lower trading prices, an "other than temporary" decrease in value may exist in the fourth quarter and, therefore, according to generally accepted accounting principles, would be marked to market. Based on trading price as of December 6, 2005, the change in valuation may result in an after-tax charge of approximately $0.8 million. The determination of the impairment and the related charge, if required, will occur on December 31, 2005, based on the closing price of the stock. Finally, the Corporation anticipates recording an after-tax expense of approximately $0.9 million in Q4 to account for severance costs related to staff reductions implemented as a result of improvements in its customer service model. This amount includes early retirement and supplemental retirement benefit costs for former employees as well as other miscellaneous items of a non-recurring nature. The future after-tax benefit of these planned expense reductions totals $1.1 million on an annualized basis. FNB to Merge with The Legacy Bank PRNewswire 12-21 In a move that expands the geographic footprint of FNB into central Pennsylvania, the Boards of Directors of F.N.B. and The Legacy Bank of Harrisburg, PA (LBOH) approved a definitive merger agreement. FNB will acquire the $382 million financial services company in a stock and cash transaction valued at $74.6 million. The merger is expected to be accretive to F.N.B. earnings per share after one full year of combined operations. The announcement follows the October 7, 2005 completion of F.N.B.'s acquisition of North East Bancshares, Inc., a $68 million financial services company that operated four banking and lending offices in Erie County, PA. In the first quarter of 2005, F.N.B. completed its acquisition of NSD Bancorp in Pittsburgh. Little Banks+Big Prices=Problem Ian McDonald, WSJ 12-22 The stocks of little banks have big price tags -- and vice versa. For the investors holding shares of small community banks hoping they will be acquired by a bigger player, that could be a problem. When smaller banks trade at prices that are higher multiples of their EPS than their bigger brethren, as they have for about two years, that is often a sign that investors are betting on takeover activity. But today's lower valuations for shares of big banks -- despite fatter dividends than smaller banks -- could keep them from going on a buying spree. Purchasing higher-priced smaller fries would dilute the acquirer's per-share profits. Shares of the nation's five biggest banks ranked by assets -- including titans Citigroup and Bank of America -- trade at about 11 times their expected per-share earnings for 2006, according to Thomson Financial. For their part, community banks with local branches sprinkled across a given region are trading at multiples of their earnings that are more than 30% higher, just a hair below the average earnings multiple for the broader stock market. Shares of small community banks like Century Bancorp in Massachusetts and Capital City Bank Group in Florida, for instance, trade at more than 19 times their projected per-share profits for next year. The persistence of this valuation gap between big and small banks has many professional investors baffled. Indeed, many pros are now buying shares of big banks while eschewing the pricier shares of smaller players. "I think the width of the valuation gap today is a bit of an anomaly, and it's preventing many deals from taking place," says James Schmidt, manager of the $2.1 billion-in-assets John Hancock Regional Bank Fund. "I'd say the bigger banks are undervalued. We have a lot of small banks in the fund that trade at 18 to 19 times their earnings, while names we normally wouldn't look at like Wachovia and Bank of America are looking attractive." In addition to having lower valuations, bigger banks are also paying higher dividend yields than smaller players. The nation's five biggest banks all yield more than 3.2%. The average community bank yields a little over 2%, and the average stock in the S&P500 index yields 1.8%. So-called superregional banks like Wachovia, Wells Fargo and BB&T also average yields of more than 3%. "These banks won't do acquisitions that are dilutive," says Michael Holton, manager of the $374.3 million T. Rowe Price Financial Services Fund. "So you look at smaller banks trading at premium prices, and you think hardly any of them will be taken out at their current prices." Others may have the same idea. The KBW Bank Stock Index is up more than 12% from its lows in October, with shares of many big banks leading the way. So why the lower valuations for big banks? Investors may be worrying about the flatter "yield curve" because it cuts into these banks' profit margins. Banks typically make money by paying low short-term rates on deposits, lending that money at higher rates and pocketing the difference -- measured by a metric called "net interest margin." So, a flattening yield curve boosts the amount a bank has to pay depositors while lowering the amount it can earn on their loans. Bank profits could also be hurt if overburdened consumers start defaulting on their loans or if the overall economy slows, which would hurt loan growth. Yet professionals wonder if smaller investors have failed to note that smaller banks would face many, if not all, of these same problems. Also, recent earnings indicate that the yield curve isn't hurting profits at the big banks as much as some might have feared. "What we saw in banks' Q3 earnings reports was stabilized net-interest margins," says Jim Callahan, an analyst who covers regional and superregional banks at Morningstar. To be sure, small banks sometimes get a premium valuation because a string of smart, small deals can increase a small bank's profits by leaps and bounds but wouldn't move the needle much for a behemoth bank. Also, some analysts and investors have theorized that small-bank valuations have stayed high because smaller players may merge to trim out costs and boost profitability. But, as interest rates rise, small banks may be at a disadvantage in coming quarters since community banks typically lack the fee-based asset-management, investment-banking and capital-markets revenues of many big players. At most titans, more than 40% of revenues come from units with profits that aren't tied to the yield curve, Morningstar's Mr. Callahan notes. The yield gap between big and small banks strengthens the case for owning the Goliaths. With many of the more-dour market shamans predicting mid-to-high single-digit annual returns from stocks in coming years, Bank of America's 4.3% yield would seem striking. The higher valuations and lower yields of many smaller banks imply that investors may have wrongly been taking acquisition plans to the bank. "I firmly expect the multiple premium for small banks to shrink over the next year," T. Rowe Price's Mr. Holton says. December Ratings Changes On 12-15 AmSouth Banc downgraded by Sandler O'Neill from Hold to Sell, coverage initiated at Underweight on FirstMerit Corp by JP Morgan, and coverage initiated on Citizens Banking at Underweight by JP Morgan. On 12-22 JP Morgan Upgrade SNV from Underweight to Neutral. 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 |