Analyst Forum

Market Intelligence
Investors have been kind to stocks recently, and especially kind to bank stocks. Despite tapering off a bit at the end of the second quarter, the Keefe, Bruyette & Woods Bank Stock Index (BKX) still climbed nearly 12 percent during the second quarter. The S&P 500, by way of comparison, went up just 3.7 percent. Why? Speculation about rising interest rates benefits bank stocks while it might not benefit other industries, says Jim Sinegal, the director of financial services research at independent research firm Morningstar Inc. Banks may need higher interest rates, as net interest margins are getting squeezed, but higher interest rates could also hurt economic growth. Profitability improved for many banks during the quarter, although there are headwinds. The percentage of institutions with year-over-year quarterly income growth is on the decline, as economic growth has been slow and as many consumers and businesses continue to shy away from credit. Meanwhile, bank CEO pay packages have improved this year compared to last year, as banking profitability improves and as compensation is more likely tied to rising equity values rather than cash.

What’s Ahead?
Brian Gardner, senior vice president of research in Washington, D.C., for Keefe, Bruyette & Woods, a division of Stifel Financial, talked to Bank Director magazine at the end of the second quarter.

What is the mood now in Washington?
I think you see an environment in Washington which is more favorable to smaller banks and less favorable to large banks.

What’s the evidence of that?
In Dodd-Frank, the Collins amendment eliminated hybrid forms of capital called TruPS [trust preferred securities] from being included in Tier 1 capital, but grandfathered in bank holding companies with less than $15 billion in assets. Community banks had a lot of problems with the original Basel [III] proposal that changed risk weightings for mortgages. Aside from requiring banks to hold more capital for mortgages, just the complexity of the added calculations for capital was tougher for smaller banks. [Editor’s note: The revised Basel III final rule from the Federal Reserve abandons the controversial risk weighting calculation for mortgages and grandfathers in TruPS for bank holding companies with less than $15 billion in assets.]

What regulation is going to have the largest impact on banking?
Finalization [of all these different rules] would have the biggest impact right now. Sometimes, it’s not whether it’s a bad rule or a good rule, it’s just a matter of knowing the rule. I don’t expect to get a lot of clarity on risk retention and QRM [qualified residential mortgages] over the next couple of months.

For a longer version of this interview and more data on bank stocks, see Analyst Forum at BankDirector.com.

Stock Retrospective
Jim Sinegal, director of financial services research at Morningstar Inc., in Chicago, made his top picks in the first quarter: Wells Fargo & Co. of San Francisco; Capital One Financial Corp. of McLean, Virginia; and FirstMerit Corp. of Akron, Ohio. All of them beat the KBW Bank Index and the broader S&P 500 in the second quarter.

Why have these banks done so well?
The first thing we look at is valuation. We look at the quality of the business and the valuation. The reason we liked these stocks is we thought they were undervalued. Our argument was that Wells Fargo deserved even more of a premium [than it had]. Capital One has low loss rates [on its credit card portfolio]. When you look at FirstMerit, we thought the market was too negative on its deal to buy Citizens Republic [Bancorp., of Flint, Michigan].