Negative Outlook On U.S. Banks

We continue to maintain a negative outlook on the U.S. Banks.

While the programs launched by the U.S. Treasury and the Federal Reserve to boost the capital levels and alleviate the liquidity problems have helped the capital and funding concerns to a great extent, the efforts have not succeeded in restoring the lending activity at banks. Lower lending activity will continue to hurt the margins though the low interest rate environment should be beneficial to the banks with a liability sensitive balance sheet.

During the current year, the banks have mainly suffered due to the losses in the mortgages and residential construction loans. As not much has been done so far to address the fundamental problems of declining home values and rising foreclosures and given the sharp increase in the level of unemployment, we anticipate continued losses in these portfolios.

Further, with the deterioration in the overall economic environment, we anticipate the losses will increase in all the other asset classes as well, especially in the commercial real estate loan and home equity loan portfolios. As a result of rise in charge-offs, the levels of reserve coverage has fallen over the past quarters and the banks will have to make higher provisions through FY09, hurting the profitability.

Opportunities

We currently do not see any opportunity and thus do not have a buy recommendation on any stocks within this industry.

Weaknesses

The banks with high exposure to housing and Commercial Real Estate loans like KeyCorp (KEY), Zions Bancorporation (ZION), and Comerica Incorporated (CMA) will continue to remain under pressure. We also maintain Sell recommendation on Freddie Mac (FRE), and Sallie Mae (SLM) as we anticipate rising losses and increased provisions through FY09.

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