Maintaining A Negative Outlook On US Banks

We continue to maintain a negative outlook on the U.S. banks. The new Financial Stability plan announced by the Treasury Secretary recently falls short on the details, and we think that the benefits, if any, will take a long time to come by. While the earlier programs launched by the Treasury and the Federal Reserve to boost the capital levels and alleviate the liquidity problems (including capital injections and debt guarantee programs) 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.

For the last few quarters, the banks have mainly suffered due to the losses in the mortgages and CRE (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, deterioration in other Commercial Real Estate loans has started rather recently, and the downturn in this class in also likely to be very challenging.

With the deterioration in the overall economic environment, and rising job losses, we anticipate the losses will increase in all the other asset classes as well, especially in the consumer related loans. It was recently reported that U.S. credit card delinquencies rose to a record high in January and are expected to rise further. We expect the asset quality deterioration to continue at least though the end of FY09.

As a result of a rise in charge-offs, the levels of reserve coverage have fallen over the past quarters and the banks will have to make higher provisions in the coming quarters, affecting the profitability. Further, the banks will also continue to take mark-downs in the investment portfolios, further hurting the bottom-line.

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 Wilmington Trust Corporation (WL), KeyCorp (KEY), Zions Bancorp (ZION) and Comerica (CMA) will remain under pressure. We also maintain Sell recommendations on Freddie Mac (FRE) and Sallie Mae (SLM) as we anticipate rising losses and increased provisions through FY09.

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