North America Equity Research 05 October 2010 Large Cap Banks Better Than Expected Net Int Income, Strong Mortgage Banking Likely to Drive 3Q Above Expectations Large Cap Banks Vivek Juneja AC (1-212) 622-6465 [email protected]Polly P. Sung, CFA (1-212) 622-0551 [email protected]Thomas W. Curcuruto (1-212) 622-5158 [email protected]J.P. Morgan Securities LLC See page 27 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. See our recent reports: Interest Rate Tracker: Lower Rates and Refi Concerns Overdone – Impact Modest Due to Offsets, 9/7 Regulatory Spotlight: Basel 3: Less Onerous, But Some Divestitures? Negative for C&I Loans, Economy, 8/6 Post 2Q: Credit Improvement Outpaced Revenue Pressure in 2Q But Balance May Shift in 2H10, 7/29 Political Spotlight: Reconciled Finc'l Reform Bill: The Beginning, Not the Finale; Impact Changes in 5 Yrs, 6/29 We expect banks’ 3Q earnings to beat consensus led by strong mortgage banking revenues and better than expected net interest income from a slower drop in earning assets. And both of these are likely to benefit 4Q. In addition, trading revenues qoq (ex CVA) are likely to not be as bad as feared in our universe, with investment banking fees mixed. Most credit metrics should improve in 3Q, although we expect the pace of further improvement to slow near term with sticky unemployment. Reg E should be the key source of fee revenue pressure in 3Q but eventually likely less than feared. And we expect small share repurchases at a couple of banks. We are therefore raising our 3Q10 and 2010 EPS estimates. We are trimming our 2011 and 2012 EPS to reflect a slower recovery resulting in slower decline in credit losses and loan growth. • What ails bank stocks? The combination of economic uncertainty and uncertainty on the political and regulatory fronts has paralyzed bank stocks. Our bank universe is attractively valued, trading at 0.9 times book value, 1.3 times tangible book value, and 8.0 times 12E EPS, on average. Better 3Q and potentially 4Q EPS results and a more balanced political environment post early November elections are two catalysts near term that should benefit bank stocks. Stocks that could especially benefit from better than expected 3Q results include WFC, BAC, and STI. • Recent $30 bil likely sale of mortgage loans in mid Sep should add to what should be a strong 3Q in mortgage banking from sharply higher refis and higher margins plus generally strong MSR hedge. Average gain on sale spreads rose about 25 bp (38%) qoq in 3Q, up to levels seen in 1H09. Originations should remain high as sharply higher refis offset a drop in purchase volumes. Mortgage repurchase expenses will likely remain high but are lumpy and likely temporarily decline in 3Q at some banks, up at others, but we expect this to be a drag for a couple of years. • Sharp decline in cash and lower deposit costs bode well for better than expected net interest income in 3Q. There was a sharp $30 bil (~7% unannualized) qoq drop in cash, which was reinvested into securities, up about 8% qoq (unannualized)—half in Treasuries and half MBS. Average loan decline slowed, led by C&I loans, which were up on a period-end basis. We expect core net interest margins (excluding purchase accounting accretion) to be mixed—up at the regionals and continued but slower decline at money centers due to redeployment of some of the large amount of cash on hand. There is some increased interest rate risk from MBS purchases, but this is reduced by purchases of some shorter duration tranches and loans. Deposit costs are likely to decline for several more quarters. • Trading revenues are likely to be mixed in our universe. Among the money centers, Bank of America could benefit from a very weak 2Q comparison in contrast to Citi, and all our banks should benefit from better than expected volumes in some fixed income sectors and lack of losses seen in 2Q (such as in equity derivatives). Investment banking fees are also likely to be mixed due to benefit from investment grade debt underwriting offsetting lower equity underwriting and M&A volumes. • Credit metrics should continue to improve with lower delinquencies and credit losses as well as some further loan loss reserve releases, albeit at a slower rate than 2Q. BB&T is likely to be the outlier in our universe in this regard.
Transcript
North America Equity Research 05 October 2010
Large Cap Banks
Better Than Expected Net Int Income, Strong Mortgage Banking Likely to Drive 3Q Above Expectations
See page 27 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
See our recent reports:
Interest Rate Tracker: Lower Rates and Refi Concerns Overdone – Impact Modest Due to Offsets, 9/7
Regulatory Spotlight: Basel 3: Less Onerous, But Some Divestitures? Negative for C&I Loans, Economy, 8/6
Post 2Q: Credit Improvement Outpaced Revenue Pressure in 2Q But Balance May Shift in 2H10, 7/29
Political Spotlight: Reconciled Finc'l Reform Bill: The Beginning, Not the Finale; Impact Changes in 5 Yrs, 6/29
We expect banks’ 3Q earnings to beat consensus led by strong mortgage banking revenues and better than expected net interest income from a slower drop in earning assets. And both of these are likely to benefit 4Q. In addition, trading revenues qoq (ex CVA) are likely to not be as bad as feared in our universe, with investment banking fees mixed. Most credit metrics should improve in 3Q, although we expect the pace of further improvement to slow near term with sticky unemployment. Reg E should be the key source of fee revenue pressure in 3Q but eventually likely less than feared. And we expect small share repurchases at a couple of banks. We are therefore raising our 3Q10 and 2010 EPS estimates. We are trimming our 2011 and 2012 EPS to reflect a slower recovery resulting in slower decline in credit losses and loan growth.
• What ails bank stocks? The combination of economic uncertainty and uncertainty on the political and regulatory fronts has paralyzed bank stocks. Our bank universe is attractively valued, trading at 0.9 times book value, 1.3 times tangible book value, and 8.0 times 12E EPS, on average. Better 3Q and potentially 4Q EPS results and a more balanced political environment post early November elections are two catalysts near term that should benefit bank stocks. Stocks that could especially benefit from better than expected 3Q results include WFC, BAC, and STI.
• Recent $30 bil likely sale of mortgage loans in mid Sep should add to what should be a strong 3Q in mortgage banking from sharply higher refis and higher margins plus generally strong MSR hedge. Average gain on sale spreads rose about 25 bp (38%) qoq in 3Q, up to levels seen in 1H09. Originations should remain high as sharply higher refis offset a drop in purchase volumes. Mortgage repurchase expenses will likely remain high but are lumpy and likely temporarily decline in 3Q at some banks, up at others, but we expect this to be a drag for a couple of years.
• Sharp decline in cash and lower deposit costs bode well for better than expected net interest income in 3Q. There was a sharp $30 bil (~7% unannualized) qoq drop in cash, which was reinvested into securities, up about 8% qoq (unannualized)—half in Treasuries and half MBS. Average loan decline slowed, led by C&I loans, which were up on a period-end basis. We expect core net interest margins (excluding purchase accounting accretion) to be mixed—up at the regionals and continued but slower decline at money centers due to redeployment of some of the large amount of cash on hand. There is some increased interest rate risk from MBS purchases, but this is reduced by purchases of some shorter duration tranches and loans. Deposit costs are likely to decline for several more quarters.
• Trading revenues are likely to be mixed in our universe. Among the money centers, Bank of America could benefit from a very weak 2Q comparison in contrast to Citi, and all our banks should benefit from better than expected volumes in some fixed income sectors and lack of losses seen in 2Q (such as in equity derivatives). Investment banking fees are also likely to be mixed due to benefit from investment grade debt underwriting offsetting lower equity underwriting and M&A volumes.
• Credit metrics should continue to improve with lower delinquencies and credit losses as well as some further loan loss reserve releases, albeit at a slower rate than 2Q. BB&T is likely to be the outlier in our universe in this regard.
Equity Ratings and Price Targets Mkt Cap Rating Price Target Company Symbol ($ bn) Price($) Cur Prev Cur Prev Bank of America BAC 131.93 13.15 OW n/c 21.00 n/cBB&T Corporation BBT 16.68 24.07 N n/c 33.50 36.00Citigroup Inc. C 116.77 4.03 OW n/c 6.00 5.50Fifth Third Bancorp FITB 9.48 11.90 UW n/c 15.00 13.00PNC Financial Services Group, PNC 27.35 52.10 OW n/c 83.00 77.00Regions Financial Corp. RF 9.09 7.24 N n/c 9.00 n/cSunTrust Banks, Inc. STI 13.06 26.13 N n/c 34.00 31.50U.S. Bancorp USB 41.45 21.62 OW n/c 34.00 31.50Wells Fargo WFC 132.77 25.38 OW n/c 43.00 39.00Source: Company data, Bloomberg, J.P. Morgan estimates. n/c = no change. All prices as of 04 Oct 10.
Estimate Changes We are generally raising our 3Q10 and full-year 2010 EPS estimates largely to reflect (1) higher mortgage production revenues on higher origination volumes and gain on sale margins and (2) better net interest income, particularly at regional banks, with benefit from higher amount of securities and lower deposit costs offsetting the impact of declining loans. We are modestly reducing our 2011 and 2012 EPS estimates primarily to reflect a slower pace of economic recovery resulting in a slower pace of improvement in credit costs and slower recovery in loans. Furthermore, we are establishing our December 2011 price targets, assuming a median price to tangible book value multiple of 1.8 times, which implies 11 times our normalized EPS (undiscounted).
Bank stocks are attractively valued, trading at 0.9 times price to book, 1.3 times price to tangible book, and 8.0 times price to 2012E EPS, on average.
Table 1: Summary of EPS Estimate Changes $ per share 3Q10E 2010E 2011E 2012E New Old Change New Old Change New Old Change New Old Change BAC * 0.15 0.10 0.05 0.87 0.77 0.10 1.40 1.40 - 2.20 2.25 (0.05) BBT 0.29 0.36 (0.07) 1.14 1.35 (0.21) 1.85 2.40 (0.55) 3.00 3.35 (0.35) C 0.05 0.05 - 0.36 0.36 - 0.49 0.49 - 0.59 0.59 - FITB** 0.16 0.01 0.15 0.39 0.11 0.28 0.90 0.87 0.03 1.35 1.42 (0.07) PNC *** 1.27 1.09 0.18 5.10 4.72 0.38 5.40 5.50 (0.10) 6.55 6.70 (0.15) RF (0.09) (0.17) 0.08 (0.64) (0.76) 0.12 0.21 0.23 (0.02) 0.81 0.85 (0.04) STI 0.02 (0.27) 0.29 (0.59) (1.04) 0.45 0.85 0.90 (0.05) 2.60 2.80 (0.20) USB 0.44 0.41 0.03 1.67 1.61 0.06 2.25 2.32 (0.07) 2.70 2.75 (0.05) WFC 0.56 0.47 0.09 2.08 1.98 0.10 2.60 2.75 (0.15) 3.55 3.67 (0.12) Source: J.P. Morgan estimates and Bloomberg. * BAC 3Q10E and 2010E estimates exclude $8.5 bil goodwill impairment. ** FITB 3Q10E and 2010E estimates exclude BOLI gain of $125 mil. *** PNC 2010E estimates exclude gain on GIS sale (3Q10) and write-off of TARP discount (1Q10).
Mortgage Banking Strong into 4Q: Higher Originations and Gain on Sale Spreads
We expect core mortgage production revenues (excluding additions to mortgage repurchase reserves) to benefit primarily from sharply higher origination volumes and gain on sale spreads in 3Q10. Refi activity surged in 3Q, benefiting from drop in mortgage rates to historically low levels, and more than offset significantly lower purchase activity following the expiry of the first time homebuyers tax credit. Total mortgage application index rose 16% on average qoq in 3Q (on lagged basis) as refi applications rose 43% qoq (up 45% seasonally adjusted) but purchase activity fell 28% qoq (down 26% seasonally adjusted). As shown in Figure 1, refi applications have declined recently but remain well above 1Q levels, which should also benefit 4Q. Furthermore, gain on sale spreads have widened considerably in 3Q (see Figure 3), close to the high levels seen in 1H09, which also bodes well for 4Q. Mortgage repurchase expenses (charge-offs and reserve builds) are likely to be mixed—up for some and down at others as it is likely to remain lumpy from quarter to quarter for the medium term.
Figure 1: Refi Activity Rose Sharply in 3Q . . . Refi applications index, not seasonally adjusted
Figure 2: . . . Driving Rise in Total Applications Total applications index, not seasonally adjusted
200300400500600700800900
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3 Month Av g (Lagged 6 Weeks)Total Applications
Source: Mortgage Bankers Association.
Figure 3: Gain on Sale Spreads Have Also Risen Sharply Primary and Secondary MBS Spreads
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Source: Bloomberg.
Servicing revenue will likely be hurt by higher amortization expense in 3Q, but MSR net of hedging should generally do well at our banks, although we expect it to vary among the banks. Banks should continue to benefit from carry trade and being long duration as well as low volatility. Most of our bank universe recorded net MSR hedge gains in 2Q.
Net Interest Income: Cash Down, Securities Up, Loan Decline Moderating We expect net interest income to hold up better than feared in 3Q due to benefit from decline in cash, sharp growth in securities, slower decline in loans, continued growth in deposits, and further decline in deposit costs. And this benefit should continue into 4Q. Cash dropped sharply in 3Q, down about $30 bil or 7% qoq (unannualized) at large banks on a period-end basis. Core loans declined about 1.5% qoq unannualized ($60 bil) on a period-end basis, a tad slower than 2Q, but decline in average loans slowed sharply in 3Q. Period-end loans were hurt by a sharp drop (about $30 bil) in residential mortgage loans toward 3Q-end. C&I loans turned around to grow a tad on a period-end basis—on average basis, decline slowed sharply (to -1.4% qoq in 3Q from -5.5% qoq in 2Q). Credit cards and commercial real estate loans continue to be the key shrinking loan categories.
Large banks shifted cash and maturing loan proceeds heavily into securities, up 8% qoq (unannualized) on a period-end basis—the securities grew throughout 3Q so part of the benefit should reflect in 4Q. Half of the growth was in MBS and half in Treasuries and non-MBS securities (such as ABS). We understand from the banks that they have been buying mainly shorter duration tranches of CMOs and shorter duration Treasuries, which should limit interest rate risk in 2012/2013 when rates rise.
Figure 4: Loan Shrinkage Moderating Due to C&I QoQ Change (%)
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
4Q09 1Q10 2Q10 3Q10Av g C&I Av g Total
Source: Federal Reserve.
Figure 5: Banks’ Securities Have Increased Sharply in 3Q $ billions
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Source: Federal Reserve.
Table 3: Sharp Growth in Securities as Cash Fell $ billions
Favorable Deposit Trends to Support Better Net Interest Margins As detailed in our Interest Rate Tracker dated September 7th, we believe concerns about net interest margin (NIM) pressure are overdone, and we expect 3Q NIMs to hold up better than expected medium term, partly due to favorable deposit mix shift. As shown in Figure 6, total deposits for large banks fell a tad in 3Q as run-off of higher cost, large time deposits is offset partly by flattish core deposits.
A few banks could report further NIM expansion in 3Q as they continue to reduce CD costs – notably, Fifth Third, Regions Financial, and SunTrust. Among our coverage universe, CD costs at the weaker regional banks (FITB, RF and STI) exceeded 2.00% in 2Q versus the median of 1.43% as they had to keep deposit costs higher during the crisis to limit outflows. And other regionals should report flattish core net interest margins (excluding impact of purchase accounting accretion) also due to some further benefit from reduction in deposit costs, albeit less than the weaker regionals. Money centers should slow NIM decline a little by shifting some of the large amount of cash into securities.
Figure 6: Favorable Deposit Mix Shift Continued in 3Q Cumulative Change since 6/30 (%)
Pace of Credit Improvement to Slow We expect credit trends to improve further and further loan loss reserve releases, but at a slower pace due to still high unemployment levels, persistent pressure on home prices, and a slow economic recovery.
Consumer credit improvement will likely be led by credit cards as evidenced in monthly master trust data and, to a smaller extent, by auto loans. We expect residential mortgage and home equity NCOs and NPLs to remain high and sticky medium term, reflecting the economic weakness. Material further improvement will likely be driven by declines in the newly unemployed. Commercial credit trends tend to be more lumpy. Positively, the recently released Shared National Credit (SNC) exam results confirmed expectations that commercial credit trends are improving as criticized assets fell 30% yoy from very high levels in 2009. However, it could take a while for banks to work through troubled assets as criticized assets remain elevated at 17.8% of the SNC portfolio (well above levels seen in prior downturns).
Figure 7: Improvement in NCOs to Continue But at Little Slower Rate QoQ Change in NCOs (%)
-8%
-6%
-4%
-2%
0%
1Q10 2Q10 3Q10E 4Q10E
Source: Company reports and J.P. Morgan estimates. Note: Median for large cap banks under coverage.
Figure 8: Loan Loss Reserve Releases to Continue Reserves to Loans (%) and Annualized NCOs (in bp)
110115120125130135140
1Q10 2Q10 3Q10E 4Q10E3.483.503.523.543.563.583.60
Reserv es to Annualized NCOs
Reserv es to Loans
Source: Company reports and J.P. Morgan estimates. Note: Median for large cap banks under coverage.
Trading, Investment Banking Mixed But Better Than Feared Markets-related revenues are likely to be better than feared as equity markets finished up for 3Q, corporate debt underwriting rose sharply, and fixed income trading volumes held up better than feared. Bank of America should hold up better with some qoq increase in trading revenues as opposed to Citi, which is likely to be down. BAC’s increase is likely because it had a much larger 58% drop in 2Q in fixed income trading led by credit products weakness. Other smaller players in trading such as Wells Fargo should also show some recovery qoq in trading revenues due to extremely sharp declines in 2Q. Fixed income trading volumes decline was tempered by below normal seasonal decline in rates related trading and corporate bonds partly due to higher debt underwriting volumes. F/X volatility was down, but moderately. Cash equity trading volumes fell sharply, but 3Q should benefit from lack of equity derivatives trading losses.
Investment banking fees are likely to be mixed as strong fixed income underwriting fees are offset by sharp drop in equity underwriting fees (at BAC and C), loan syndication fees, and completed M&A. See Table 5. Citi seems to have held up relatively better in 3Q in investment banking fees than Bank of America, although there can be a lot of volatility from one quarter to the next.
Asset management fees may be better than feared but would depend on the metric that determines fees. S&P 500 and MSCI EAFE ended up for 3Q on a period-end basis (up 10-16% qoq), which should be a positive.
Figure 9: Markets Recovered in 3Q, but Still Down on Average
QoQ Change
-3.4%
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0.8%
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10.0%15.0%20.0%
S&P 500 MSCI EAFE
Daily Av g - 3Q10 Period End (9/30/10 v . 6/30/10)
Source: Bloomberg.
Figure 10: As Expected Trading Volumes Slowed Sharply in 3Q 10 Day Moving Average
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Equities (Right; shares in bil)
Source: Bloomberg and J.P. Morgan.
Table 5: Investment Banking Fees Up Modestly Led by Debt Underwriting QoQ Change (%) - 3Q10
Equity
Underwriting Debt
Underwriting Loan
Syndication Total ex
M&A 3Q10 BAC -26% 39% -36% -10% C -17% 105% -10% 32% Global 0% 29% -7% 9% 2Q10 BAC 22% -38% 63% 2% C -20% -49% 92% -25% Global -10% -31% 40% -31%
Bank of America Valuation and Rating Analysis Bank of America is trading at 1.1 times tangible book value, which is a tad below the large cap bank median of 1.3 times. We continue to rate Bank of America Overweight longer term relative to our universe due to relatively attractive valuation and potential for significant appreciation when earnings normalize, which are offsetting pressure on revenues from consumer related sources.
We are establishing our December 2011 price target for Bank of America at $21.00 (the same as our prior Dec 2010 target), which is based on 1.4x price to tangible book value multiple, a 20% discount to expected peer median tangible book value multiple of 1.8x. We expect BAC to trade at a discount near term due to pressure on revenues.
Risks to Our Rating and Price Target Bank of America’s business and earnings are sensitive to economic and general business conditions. Risks that may affect our outlook for the company include integration of Merrill Lynch and Countrywide acquisitions, interest rate risk, higher than expected increase in credit losses, changes in credit risk profile, changes in capital structure/adequacy, actions by ratings agencies, changes in overall economic growth and loan growth, and performance.
Overweight Company Data Price ($) 13.15Date Of Price 04 Oct 1052-week Range ($) 19.86 -
12.18Mkt Cap ($ mn) 131,934.17Fiscal Year End DecShares O/S (mn) 10,033Price Target ($) 21.00Price Target End Date
BB&T Corporation Valuation and Rating Analysis BBT is trading at 1.7 times tangible book value, which is above the large cap bank median of 1.3 times. We continue to rate BBT Neutral relative to our universe due to concerns about its commercial real estate exposure, which is creating an overhang and offsetting the benefit from several revenue strengths.
We are establishing our December 2011 price target for BB&T at $33.50 (vs. our prior Dec 2010 target of $36.00), which is based on 2.1x 2011E price to tangible book value multiple for BB&T, a 15% premium to peer group multiple of 1.8x tangible book value. We expect BBT to trade at a modest premium to the group as BBT should be a beneficiary of flight to quality, but this is partly offset by concerns about its commercial real estate exposure.
Risks to Our Rating and Price Target BBT’s business and earnings are sensitive to economic and general business conditions. Risks that may affect our rating and price target on BBT include higher or lower credit losses, especially on legacy commercial real estate related loans, including lot and construction loans, and integration of Colonial Bancorp acquisition.
Neutral Company Data Price ($) 24.07Date Of Price 04 Oct 1052-week Range ($) 35.72 -
21.72Mkt Cap ($ mn) 16,675.14Fiscal Year End DecShares O/S (mn) 693Price Target ($) 33.50Price Target End Date
Citigroup Inc. Valuation and Rating Analysis Citi trades at 1.0 times price to tangible book, below peer averages. Performance should improve gradually, led by continued expansion of revenues overseas especially emerging markets, recovery in net interest income, slower expense growth, slowing, albeit still high, credit losses, and shrinkage of Citi Holdings. We maintain Citi at Overweight longer term relative to our universe due to relatively attractive valuation at current levels given the substantial increase in capital, sizable amount of loan loss reserves, and potential for faster growth from emerging markets. However, Citi’s earnings remain under pressure near term along with the industry due to still high credit related costs.
We are establishing our December 2011 price target for Citi of $6.00 (vs. our prior Dec 2010 target of $5.00), which assumes a price to tangible book value multiple of 1.3 times, a discount to the expected peer group multiple of 1.8 times. While we expect Citi to continue to trade at a discount, we expect the discount to narrow gradually along with improved performance and increased earnings visibility.
Risks to Our Rating and Price Target Citigroup’s business and earnings are sensitive to economic and general business conditions. Downside risks that may affect our outlook include regulatory risk, risks from government interference due to its large stake, interest rate risk, higher than expected increase in credit losses, significant deterioration in credit risk profile, changes in capital structure/adequacy, actions by ratings agencies, changes in overall economic and loan growth, and performance of the equity and fixed income markets. Lastly, given a global franchise and presence in emerging markets, Citigroup is subject to geopolitical risk and material economic downturn outside of the U.S.
Overweight Company Data Price ($) 4.03Date Of Price 04 Oct 1052-week Range ($) 5.07 - 3.11Mkt Cap ($ mn) 116,770.86Fiscal Year End DecShares O/S (mn) 28,975Price Target ($) 6.00Price Target End Date 31 Dec 11
Fifth Third Bancorp Valuation and Rating Analysis Fifth Third stock has appreciated very sharply since YE’09 due to expectations of a return to historical profitability levels by 2012. However, we expect Fifth Third to be relatively more impacted than peers from higher than historical level of credit costs due to significant deterioration in its footprint where the bank had rapid loan growth over the past couple of years, sale of part of a high ROA/ROE business (payment processing), and decline in large sources of fee revenues that have material impact on profitability (deposit service charges and to a lesser extent, mortgage banking). FITB is trading at 1.3 times tangible book value, which is a tad below regional bank median but close to some high-quality banks. Therefore, we rate FITB Underweight only on a relative basis to our coverage universe based on valuation.
We are establishing our December 2011 price target for Fifth Third of $15.00 (vs. our prior Dec 2010 target of $13.00), which assumes a price to tangible book value multiple of 1.4 times. We expect Fifth Third to continue to trade at a discount to the peer group multiple of 1.8 times owing to a relatively weaker footprint and lower profitability.
Risks to Our Rating and Price Target Fifth Third's business and earnings are sensitive to economic and general business conditions. Risks that may affect our rating on Fifth Third include better than expected recovery of Midwest economy, lower than anticipated credit losses, and significant improvement in credit risk profile and capital adequacy.
Underweight Company Data Price ($) 11.90Date Of Price 04 Oct 1052-week Range ($) 15.95 - 8.76Mkt Cap ($ mn) 9,476.21Fiscal Year End DecShares O/S (mn) 796Price Target ($) 15.00Price Target End Date 31 Dec 11
PNC Financial Valuation and Rating Analysis PNC trades at 1.6x tangible book value and 8.0x estimated normalized (2012) EPS. Excluding its BlackRock stake, PNC is trading at 7.4 normalized earnings, which is below the regional bank peer median of 8.8x. PNC is one of the flight to quality banks in the industry that is gaining share in this environment, benefiting from its Nat City acquisition, and we believe it is attractively valued. Therefore, we rate PNC Overweight relative to peers.
We are establishing our December 2011 price target for PNC at $83.00 (vs. our prior Dec 2010 target of $77.00), which is based on 1.9x price to tangible book value multiple, a modest premium to expected peer median tangible book value multiple of 1.8x.
Risks to Our Rating and Price Target PNC’s business and earnings are sensitive to economic and general business conditions. Risks that may affect our rating and/or price target on PNC include higher than anticipated credit losses on legacy PNC loans and legacy NCC loans, change in senior management lineup, slower than expected recovery in capital ratios, and volatility in the value of PNC’s large stake in BlackRock, which represents about 14% of PNC’s market cap.
Overweight Company Data Price ($) 52.10Date Of Price 04 Oct 1052-week Range ($) 70.45 -
43.37Mkt Cap ($ mn) 27,352.50Fiscal Year End DecShares O/S (mn) 525Price Target ($) 83.00Price Target End Date
31 Dec 11
PNC Financial Services Group, Inc. (PNC;PNC US) 2009A 2010E
Regions Financial Valuation and Rating Analysis Regions trades at a discount to our overall universe and the mid sized regionals at 1.1 times tangible book. We rate Regions Neutral relative to peers due to elevated credit losses and credit-related expenses, which should result in continued losses near term and slow its return to normalized earnings.
We are establishing our December 2011 price target for Regions Financial of $9.00 (the same as our prior Dec 2010 target), which assumes a price to tangible book value multiple of 1.4 times versus the peer group multiple of 1.8x. We expect Regions to continue to trade at a discount to the group in 2011.
Risks to Our Rating and Price Target Regions’ business and earnings are sensitive to economic and general business conditions. Risks that may affect our outlook and rating for the company include regulatory risk, interest rate risk, higher than expected increase in credit losses, changes in credit risk profile, changes in capital structure/adequacy, actions by ratings agencies, changes in overall economic growth and loan growth, and performance. Also, recent class action lawsuits and arbitrations involving Morgan Keegan could adversely impact operating results and pose downside risk to our Neutral rating.
Neutral Company Data Price ($) 7.24Date Of Price 04 Oct 1052-week Range ($) 9.33 - 4.61Mkt Cap ($ mn) 9,093.44Fiscal Year End DecShares O/S (mn) 1,256Price Target ($) 9.00Price Target End Date 31 Dec 11
SunTrust Banks, Inc. Valuation and Rating Analysis SunTrust stock trades at 1.1 times tangible book value, below the median of 1.3 times for overall regional banks but closer to mid sized regionals. SunTrust continues to face credit quality and revenue pressures, and we rate the stock Neutral relative to its peers due to continued losses near term and relatively higher medium-term earnings pressures.
We are establishing our December 2011 price target for SunTrust of $34.00 (vs. our prior Dec 2010 target of $31.50), which assumes a price to tangible book value multiple of 1.4 times versus the peer group multiple of 1.8x. We continue to expect STI to trade at a discount to peers reflecting relatively higher credit-related costs and revenue pressures.
Risks to our Rating and Price Target SunTrust’s business and earnings are sensitive to economic and general business conditions, particularly in the southeast. Risks that may affect our outlook for the company and our rating include regulatory risk, interest rate risk, higher than expected credit losses, changes in credit risk profile, changes in capital structure/adequacy, actions by ratings agencies, changes in overall economic growth and loan growth, and performance of the equity and fixed income markets.
Neutral Company Data Price ($) 26.13Date Of Price 04 Oct 1052-week Range ($) 32.02 -
18.45Mkt Cap ($ mn) 13,063.13Fiscal Year End DecShares O/S (mn) 500Price Target ($) 34.00Price Target End Date
U.S. Bancorp Valuation and Rating Analysis We continue to rate U.S. Bancorp Overweight relative to the large cap peer group of bank stocks due to our expectations for lower drag from the financial reform bill, favorable business mix, above-average earnings and tangible book value growth, and attractive valuation. Furthermore, the stock has lagged recently as investors chased the credit recovery. We expect USB to catch up as investors remain skittish and seek higher quality names with lesser risk due to concerns about Europe, some uncertainty about the economic recovery, and political uncertainty. USB is currently trading at 8.0x our 2012E EPS, which is in the middle of our coverage group, but given lower risk profile and above-average earnings growth, USB should trade at a higher P/E multiple on a normalized basis, which implies significant potential stock upside.
We are establishing our December 2011 price target for U.S. Bancorp of $34.00 (vs. our prior Dec 2010 target of $31.50), which assumes a price to tangible book value multiple of 3.1 times versus the peer group multiple of 1.8x. USB has consistently traded well above peers on P/TB and P/B multiples, and we expect this to continue due to its profitability and lower risk profile.
Risks to our Rating and Price Target U.S. Bancorp's business and earnings are sensitive to economic and general business conditions. Risks that may affect our outlook for the company and rating include interest rate risk, changes in credit risk profile, changes in capital structure/adequacy, regulatory risk, actions taken by ratings agencies, changes in overall economic and loan growth, and performance of the equity and fixed income markets. Furthermore, sharply higher than anticipated credit losses and/or lower pretax preprovision profit would pose downside risk to our rating.
Overweight Company Data Price ($) 21.62Date Of Price 04 Oct 1052-week Range ($) 28.43 -
20.44Mkt Cap ($ mn) 41,445.54Fiscal Year End DecShares O/S (mn) 1,917Price Target ($) 34.00Price Target End Date
Wells Fargo Valuation and Ratings Analysis We continue to rate Wells Fargo Overweight because of its solid longer term track record versus its peers. Wells Fargo is trading at 1.8 times tangible book value, which is above the large-cap banks’ median multiple of 1.3 times because of the divergence between flight-to-quality banks and weaker banks.
We are establishing our December 2011 price target for Wells Fargo at $43.00 (vs. our prior Dec 2010 target of $39.00), which is based on 2.3x price to tangible book value multiple and peer group multiple of 1.8x tangible book value. We continue to expect WFC to trade at a material premium to the group because of its strong long-term track record.
Risks to our Rating and Price Target Wells Fargo's business and earnings are sensitive to economic and general business conditions. Risks that may affect our rating and price target on Wells Fargo include integration of Wachovia, significant deterioration in asset quality beyond our expectations (including SOP 03-3 impaired loans), sustainability of pre-provision profit, ability to continue to benefit from flight to quality in loans and deposits, and political/regulatory changes impacting consumer banking and mortgage businesses.
Overweight Company Data Price ($) 25.38Date Of Price 04 Oct 1052-week Range ($) 34.25 -
23.02Mkt Cap ($ mn) 132,772.82Fiscal Year End DecShares O/S (mn) 5,231Price Target ($) 43.00Price Target End Date
Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
• Market Maker: JPMS makes a market in the stock of Fifth Third Bancorp. • Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Bank of
America, Citigroup Inc., PNC Financial, Regions Financial, U.S. Bancorp, Wells Fargo within the past 12 months. • Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of Bank of
America, Citigroup Inc., U.S. Bancorp, Wells Fargo. • Client of the Firm: Bank of America is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to
the company investment banking services, non-investment banking securities-related service and non-securities-related services. BB&T Corporation is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Citigroup Inc. is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Fifth Third Bancorp is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company non-investment banking securities-related service and non-securities-related services. PNC Financial is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Regions Financial is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. SunTrust Banks, Inc. is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company non-investment banking securities-related service and non-securities-related services. U.S. Bancorp is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Wells Fargo is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services.
• Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services from Bank of America, BB&T Corporation, Citigroup Inc., PNC Financial, Regions Financial, U.S. Bancorp, Wells Fargo.
• Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from Bank of America, BB&T Corporation, Citigroup Inc., Fifth Third Bancorp, PNC Financial, Regions Financial, U.S. Bancorp, Wells Fargo.
• Non-Investment Banking Compensation: JPMS has received compensation in the past 12 months for products or services other than investment banking from Bank of America, BB&T Corporation, Citigroup Inc., Fifth Third Bancorp, PNC Financial, Regions Financial, SunTrust Banks, Inc., U.S. Bancorp, Wells Fargo. An affiliate of JPMS has received compensation in the past 12 months for products or services other than investment banking from Bank of America, BB&T Corporation, Citigroup Inc., Fifth Third Bancorp, PNC Financial, Regions Financial, SunTrust Banks, Inc., U.S. Bancorp, Wells Fargo.
• J.P. Morgan and/or its affiliates is acting as financial advisor to Ameriprise Financial Inc (NYSE: AMP) in connection with its definitive agreement to acquire the long-term asset management business of Columbia Management from Bank of America Corp (NYSE: BAC) as announced on September 30, 2009. The transaction is subject to customary regulatory reviews and approvals. It is expected to close in the spring of 2010.
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Jul 08, 2004. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Jun 08, 2007. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
08-Jun-07 N 41.54 - 03-Dec-08 N 27.60 30.00 12-Jan-09 N 22.17 26.00 14-Aug-09 N 28.23 31.00 13-Oct-09 N 27.77 35.00 11-Jan-10 N 27.34 32.50 12-Apr-10 N 34.05 36.00
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Feb 23, 2007. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Jul 08, 2004. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Dec 17, 2009. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
17-Dec-09 OW 52.00 70.00 12-Apr-10 OW 65.27 77.00
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Regions Financial (RF) Price Chart
N $6
N $9 N $7.5
N N $10 N $6.5 N $9
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Initiated coverage Dec 17, 2007. This chart shows J.P. Morgan's continuing coverage of this stock; the current analystmay or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
17-Dec-07 N 23.89 - 03-Dec-08 N 9.94 10.00 12-Jan-09 N 7.02 9.00 20-Jan-09 N 4.60 6.00 10-Jul-09 N 3.84 6.50 19-Aug-09 N 5.44 7.50 12-Apr-10 N 8.74 9.00
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Oct 06, 2003. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
13-Jan-09 N 23.67 33.50 09-Mar-09 N 10.09 20.50 10-Jul-09 N 15.32 22.00 19-Aug-09 N 20.46 26.00 09-Oct-09 N 22.33 28.00 12-Apr-10 N 29.44 31.50
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U.S. Bancorp (USB) Price Chart
N $21
N $13 N $31.5
N $27 N $28.5 OW $31.5
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Dec 30, 2003. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
13-Jan-09 N 21.68 27.00 09-Mar-09 N 10.19 13.00 01-May-09 N 17.96 21.00 19-Aug-09 N 21.51 28.50 09-Oct-09 N 22.60 31.50 26-May-10 OW 23.63 31.50
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Sep 12, 2002 - Dec 16, 2003. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] J.P. Morgan Cazenove’s UK Small/Mid-Cap dedicated research analysts use the same rating categories; however, each stock’s expected total return is compared to the expected total return of the FTSE All Share Index, not to those analysts’ coverage universe. A list of these analysts is available on request. The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.
Coverage Universe: Vivek Juneja: BB&T Corporation (BBT), Bank of America (BAC), Bank of New York Mellon Corp. (BK), Citigroup Inc. (C), Fifth Third Bancorp (FITB), Northern Trust (NTRS), PNC Financial (PNC), Regions Financial (RF), State Street (STT), SunTrust Banks, Inc. (STI), U.S. Bancorp (USB), Wells Fargo (WFC)
J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2010
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.
Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on the front of this note or your J.P. Morgan representative.
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